Italy buckled to world pressure in a bid to halt a market rout endangering the global economy, pledging to speed up austerity measures and social reforms in return for European Central Bank help with funding.
About $2.5 trillion has been wiped off world stocks this week on worries the euro zone debt crisis was spreading and the U.S. was slipping into recession. Better than expected U.S. jobs growth in July helped support Wall Street on Friday but stocks slipped back into the red in late trading.
After a frantic round of telephone diplomacy, Italian Prime Minister Silvio Berlusconi said his government would bring forward cuts to balance the budget in 2013, a year ahead of schedule, and rush through welfare and labor market reforms.
We consider it appropriate to introduce an acceleration of the measures which we introduced recently in the fiscal planning law to give us the possibility of reaching our objective of balancing the budget early, by 2013 instead of 2014, Berlusconi told a news conference after a day of calls with world leaders including German Chancellor Angela Merkel and U.S. Treasury Secretary Tim Geithner.
Sources close to the matter told Reuters the European Central Bank had demanded such measures in exchange for buying bonds to ease the pressure on Italy, which has come under market attack.
There was no immediate reaction from the ECB but a European Commission spokesman said the measures responded to assessments set out earlier in the day by EU Economic and Monetary Affairs Commissioner Olli Rehn and go in the right direction.
Investors have been unimpressed by a 48 billion euros austerity package passed by Berlusconi's government, partly because most of the measures were delayed until after elections scheduled for 2013, for clear political reasons.
The leaders of Germany, France and Spain conferred on the crisis by telephone during the day and French President Nicolas Sarkozy, who heads the Group of Seven industrialized powers and the G20 this year, said he would talk to U.S. President Barack Obama.
Discord among EU policymakers over how to stop a disastrous spread of the sovereign debt crisis to Italy and Spain, the euro zone's third and fourth biggest economies, has caused increasing frustration among investors.
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.
That now appears to have been a gambit to force Italy to act.
In principle it is right to say that the ECB could start buying Spanish and Italian bonds if they made an extra effort with fiscal and structural reforms, a senior euro zone official told Reuters.
Bank of Spain governor Jose Manuel Gonazalez-Paramo, a member of the ECB's governing council, said he expected Spain to announce further measures on August 19 to ensure it meets its budget austerity targets.
Earlier in the day, China and Japan called for coordinated action to avert a new worldwide crisis sourced to Europe and the United States, as did 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.
Britain called for a concerted international effort to show governments would work together to avert a financial crisis and Brazil also urged unity, saying the world economy was in a situation of stress.
The ECB reactivated its dormant bond-buying program on Thursday in an attempt to address 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.
Berlusconi's declaration may have broken the impasse.
This will help overcome opposition by these ... figures in the governing council and facilitate ECB intervention, which is the only thing that can stabilize the market now. I don't see how we can survive another week like this one, one source involved in the talks said.
But more profound decisions will need to be taken, and soon.
Investors said policy differences among European Union governments and central bankers were heightening anxiety about Europe's will to stem the debt crisis.
To bail out Spain would test the fund's existing firepower to the limit while doing so for Italy would overwhelm it although Rehn insisted neither would require assistance.
In the first analyst comment on Berlusconi's announcement, Chiara Corsa, vice-president of Unicredit Research, said: This is the response we were hoping to see and there are no doubts that the government pledged to deliver what has been called for, to say the least.
However she noted that Berlusconi and Economy Minister Giulio Tremonti had omitted to respond to EU calls for more liberalization of the economy to boost growth, adding that whether they had done enough to calm market turmoil depends on whether the market believes it or not.
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.
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.
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.
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, realization 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 Paul Taylor in Paris, 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 Paul Taylor, Barry Moody and Mike Peacock; editing by Janet McBride)