European leaders came under heavy pressure on Friday to take decisive action to stem a spiralling debt crisis while robust U.S. jobs data brought some relief to battered world markets.
Fears of U.S. recession and the spreading euro zone crisis has wiped $2.5 trillion off world stocks this week.
Better than expected U.S. jobs growth in July helped Wall Street open higher, gaining back at least some of the previous session's sharp losses, but the Dow Jones Industrial Average soon subsided to stand flat on the day.
The leaders of Germany, France and Spain scheduled crisis talks later in the day after China and Japan called for global policy cooperation to stop panic on the markets.
Discord among EU policymakers over how to stop a disastrous spread of the crisis to Italy and Spain has caused increasing frustration among investors who have also been spooked by fears that the United States could slip into recession.
Most notably, the European Central Bank disappointed markets by buying Irish and Portuguese bonds but not government paper in Italy and Spain where bond yields have blown out this week on fears that they may need bailing out.
Would the ECB please get serious, Berenberg private bank said in a note reflecting global concern. We need a circuit breaker to stop the vicious circle in which fear feeds on fear.
The ECB is holding back help for Italy and Spain, the euro zone's third and fourth biggest economies, to force them to toughen austerity measures, including bringing them forward.
Italy's austerity package has been criticised for back loading the most important measures until after an election scheduled for 2013, clearly for political reasons.
The call for coordinated action from China and Japan was echoed by European Economic and Monetary Affairs Commissioner Olli Rehn.
International policy coordination through the G7 and G20 is of critical importance, he told a news conference, having broken off his vacation and returned to Brussels.
Some of the reasons for these tensions relate to developments outside the euro area. Investor sentiment has been negatively affected by the impact of the debt ceiling negotiation in the United States and by recent data suggesting a softer patch in the global economy.
ECB executive board member Jose Manuel Gonzalez-Paramo joined the chorus calling for urgent and decisive action, although he said there was no need for panic.
French President Nicolas Sarkozy was to discuss the situation with German Chancellor Angela Merkel and Spanish Prime Minister Jose Luis Rodriguez Zapatero in separate telephone calls on Friday evening, his office said.
The ECB reactivated its dormant bond-buying programme on Thursday in an attempt to hose down the euro zone's deepening sovereign debt crisis, but only bought Portuguese and Irish debt. Influential members of the ECB opposed even that.
Central bank sources told Reuters that four out of 23 ECB governing council members, including powerful German Bundesbank chief Jens Weidmann, voted against the decision to resume any bond purchases.
Traders said the central bank intervened for a second day on Friday, but was again only buying Portuguese and Irish paper. Pressure eased on Italian and other peripheral debt but Italy's 10-year-yields overtook those of Spain for the first time since May 2010 and both yields remained above 6 percent, confirming investors concerns about the lack of action.
Recent developments mainly reflect an increasing scepticism about the systemic capacity of the euro area to respond to the ongoing crisis, Greek Prime Minister George Papandreou wrote in a letter to European Commission President Jose Manuel Barroso, echoing an assessment from Barroso himself earlier this week.
Investors said policy differences among European Union governments and central bankers were heightening anxiety about Europe's will to stem the debt crisis.
In Europe, central banks and governments are not marching in step, said Georg Schuh, chief investment officer of Deutsche Bank's asset management arm DB Advisors, adding that the next four to six weeks would be crucial.
To bail out Spain would test the fund's existing firepower to the limit while doing so for Italy would overwhelm it but Rehn insisted neither would require assistance.
CHINA, JAPAN SEEK ACTION
In Japan, Finance Minister Yoshihiko Noda said global policymakers needed to confront currency distortions, the debt crises and concerns about the U.S. economy.
I agree that these subjects should be discussed, he told reporters a day after Japan intervened to sell yen. Each problem is important, but how to prioritise these issues is something to discuss from here on in.
Japan sold yen on Thursday to try to cap the currency's rise. It has become a popular safe-haven bet, as has the Swiss franc, as concerns about the United States and Europe grow.
Chinese Foreign Minister Yang Jiechi said U.S. debt risks were escalating and countries should step up cooperation on global economic risks.
Yang, who is visiting Poland, called on the United States to adopt responsible monetary policies and protect the dollar investments of other nations.
The U.S. Federal Reserve holds its next policy-setting meeting on Tuesday, and economists say there is little more it can do to try to spur growth.
Meanwhile, investors are worried that Italy and Spain, the euro area's third and fourth biggest economies, could be next to require bailouts after Greece, Ireland and Portugal.
Analysts said they would look to see if European leaders are willing to expand its emergency financial stability fund to an amount that would put a floor under the market panic. Currently at 440 billion euros, it would need to be doubled or tripled to cover economies as big as Italy and Spain.
Rehn said the EU should keep adapting its financial rescue fund and, in the longer term, consider common euro zone bonds.
To be effective, the EFSF needs to be credible and respected by the markets. And therefore we need to be continuously assessing it, once up and running in its objective form, with these goals in mind, he told BBC radio.
EU heavyweights Germany and France have so far opposed any common debt issuance, arguing that it would remove a key driver of fiscal discipline in individual member states and push up their own borrowing costs as AAA-rated sovereigns.
In Washington, a similar sense of inertia to Europe has taken hold.
Just days after a bitterly fought, last-minute deal to raise the country's debt ceiling and avoid default, realisation has sunk in that many elements of the $2.1 trillion deficit reduction plan are not locked in place.
Doubt has spread through markets that Congress will stick to implementing it in full after the November 2012 elections.
(Additional reporting by Kathrin Jones and Sakari Suoninen in Frankfurt, Leika Kihara in Tokyo, William James, Jeremy Gaunt and Ana Nicolai da Costa in London, Pedro da Costa, Kristina Cooke, Walter Brandimarte and Lucia Mutikani in New York and Emily Kaiser in Singapore; writing by Barry Moody and Mike Peacock)