European Union leaders meet next week under pressure to take bolder steps to quell the euro zone debt crisis, despite signs that volatility in European bond markets is abating toward the end of the year. The European commissioner for monetary affairs, Olli Rehn, said it was time for Europe to show proper coordination, and back its shared currency union with closer economic union.
We have to take well-coordinated action to safeguard stability in the euro area, Rehn said on a visit to Athens on Wednesday to review Greece's deficit-reduction efforts. We will not stop until we have accomplished our mission.
Euro zone finance ministers took no extra measures to tackle the crisis this week, saying a 750 billion euro ($1 trillion) EU/IMF fund was sufficient to deal with Ireland's bailout and any potential problems spreading to Portugal or Spain.
That inaction caused further unrest in debt markets, with yields on Greek, Irish, Portuguese and Spanish bonds all briefly rising. But traders say movements are being exaggerated by thin volumes, with investment houses traditionally closing their books before the year-end. Activity will resume in January.
Given the brutality of the moves we've seen in recent days, we may well have seen most of the negative news for bond markets, said David Page, an interest rate strategist at Lloyds TSB in London.
But EU finance officials have repeatedly warned there is no room for complacency, aware that when markets last calmed down, during July and August, it was not a signal that the crisis was over -- if anything, it has worsened since.
The risks are still there and I don't think anyone feels reassured, Marc Ostwald, a strategist at Monument Securities, said this week. This is about reassurance of leadership.
The December 16-17 EU summit is supposed to agree on the shape of a permanent mechanism for handling crises from 2013.
But the discussion will also focus on how to handle the immediate situation. There is growing divergence between Germany and other member states on what measures to take, including over whether euro area bonds make sense, and whether the European Central Bank might buy more distressed debt.
France added its voice to Germany's staunch opposition to the idea of euro bonds on Thursday, saying it saw little need for such an instrument, which would effectively mean all 16 euro zone member states sharing debt issuance and credit risk.
It raises difficulties notably in terms of sharing costs and profits, said a spokesman for French President Nicolas Sarkozy. There is no need to discuss new propositions.
SPAIN'S CAJAS A LINGERING PROBLEM
Instead, what analysts say could emerge at the summit is a commitment to enlarge, or at least look at enlarging, the 750 billion euro European financial stability facility.
Herman Van Rompuy, president of the European Council, which represents the EU's 27 states, hinted as much this week, saying: Up to now there is no need to increase the means available for the facility. If needed, we will consider (it).
He said he expected EU leaders to agree a minor change to the Lisbon treaty, the main law governing the 27-country bloc, in order to create a permanent financial stability mechanism.
Germany had requested this concession to head off a looming ruling from its constitutional court that could have stopped it from backing a financial scheme to support weaker members.
The other open question is what steps the European Central Bank may be induced to take to support action by the EU leaders. Speculation in financial markets in recent weeks has been that the ECB could launch a massive bond-buying programme -- possibly 1 trillion euros or more -- to quell market pressure.
ECB President Jean-Claude Trichet has sidestepped those suggestions, but the bank has marginally increased its purchases of Portuguese and Irish debt in recent days, market sources say.
The fact yields on the sovereign debt of Portugal, Spain and other weaker euro zone states have come off record highs may therefore tempt some EU leaders to conclude the measures being taken are working. But analysts warn against such temptation.
Daniel Gros, an economist and director of the Center For European Policy Studies, draws the analogy of a crowded cinema. If there is a large exit and lots of fire extinguishers, everyone is more comfortable in the event of a fire. The euro zone, he says, has yet to create a big enough fire exit.
For example, the Spanish banking sector alone has short-term liabilities of several hundred billion euros. To return to the cinema analogy: investors know that the exit is not large enough to allow them all to squeeze through at the same time, he wrote this week, warning that if the EU does not take big, bold decisions, it may never turn sentiment around.
Whatever decisions leaders take next week, the root causes of the crisis -- deep structural deficits, large debts and inefficient economies -- will remain. Governments have to tackle them in the coming years. In the meantime, methods have to be found to handle the pressure on sovereign and bank debt.
Next year, the euro zone will issue in the region of 800 billion euros of debt, according to Citigroup. If bond market uncertainty picks up again early next year, as analysts expect, funding that amount is going to prove taxing.
And there are other lingering problems. Spain's regional savings banks, the cajas, are under pressure to come clean on their liabilities, and potential losses, on property loans.
Spain's central bank will conduct a new round of health checks on the cajas and report back in March. Bigger hidden losses in Spain's banking sector could be a trigger for further volatility on markets and renewed euro zone debt problems.
(Additional reporting by John O'Donnell, Harry Papachristou in Athens, Emmanuel Jarry in Paris, William James in London and Fiona Ortiz in Madrid; editing by Mark Heinrich/Janet McBride)