Spain became the latest euro zone country to announce sweeping austerity measures on Wednesday as the executive European Commission sought unprecedented power to pre-vet national budgets.
Prime Minister Jose Luis Rodriguez Zapatero said Madrid would slash civil service pay by 5 percent this year, freeze it in 2011, cut investment spending and pensions and axe 13,000 public sector jobs in a drive to meet EU deficit targets.
We have to make a singular, exceptional and extraordinary effort to reduce our public deficit and we have to do it when the economy is starting to recover, he told parliament.
The announcement came two days after euro zone governments, the European Central Bank and the IMF agreed on a $1 trillion rescue package to stabilize the euro in exchange for pledges from highly indebted European countries to cut their deficits.
Portugal's finance minister said his government had picked a set of new measures for deeper spending cuts and would discuss them with the opposition before announcing them.
U.S. President Barack Obama, who has intervened in the euro zone crisis because of risks to U.S. banks and economic growth, telephoned Zapatero on Tuesday to press for resolute action to strengthen the Spanish economy, the White House said.
Spain enjoyed more than a decade of rapid growth fueled by EU regional aid and low euro interest rates, and long boasted a healthy budget balance and low debt. But public finances were severely hit by the collapse of a construction bubble in the 2007-8 credit crisis. The economy has lost competitiveness and unemployment stands at 20 percent of the workforce.
After months in denial about the need for tougher measures, Zapatero announced an estimated 6 billion euros in additional savings this year.
European shares rose despite figures showing the euro zone economy got off to a weak start in 2010 that will make deficit cutting harder, with paltry first quarter growth in Germany and France.
GREEN LIGHT FOR ESTONIA
In a reminder that east European countries are still keen to join the 16-nation single currency, Estonia won a green light from the European Commission to join the euro area in 2011.
EU finance ministers are expected to ratify the decision in June, but the Baltic state is likely to be the last country to join for at least four years because other candidate countries have seen their deficits rise beyond the EU limit in the crisis.
Spanish and Portuguese borrowing costs soared last week as investors fled peripheral euro zone government bonds amid jitters over Greece's acute debt crisis spread to other highly indebted EU countries.
But Portugal and Germany staged successful bond auctions on Wednesday after European Central Bank purchases of euro zone government debt in the market steadied investors' nerves.
In a drive to tighten fiscal discipline and prevent a re-run of Greece's fraudulent statistics and ballooning deficit, EU Economic and Monetary Affairs Commissioner Olli Rehn unveiled proposals for greater budget coordination on Wednesday.
The key plank would be for governments to submit their draft budgets to Brussels for scrutiny and peer review by other member states before they are adopted by national parliaments.
Rehn said this would enable the Commission and the European Parliament to identify economic challenges for the EU and the euro zone at an earlier stage and recommend changes.
But it is a big challenge to national fiscal sovereignty and is likely to face stiff resistance from euro zone heavyweights France and Germany, which want closer supervision of serial budget sinners' finances, but not of their own.
In a pre-emptive response, French Finance Minister Christine Lagarde suggested on Tuesday that each government should put its so-called stability and growth programme -- a three-year fiscal plan -- to a national parliamentary vote before sending it to Brussels. That could make it harder for EU officials to unpick budget measures.
The Commission also proposed a stricter use of existing sanctions, including a cut-off of EU funds to countries that violated the bloc's budget rules.
Rehn said Greece's crisis had highlighted the weakness of mechanisms which are supposed to show whether European Union governments are sticking to the bloc's budget rules.
The Eurogroup of euro zone finance ministers should also be advised in advance and therefore play a decisive role in the new system of expanded coordination, he said.
ECB policymakers, meanwhile, said their weekend decision to buy euro zone government bonds on the open market was having the desired effect in calming markets and curbing speculation.
Any observer will notice that a number of markets which had been functioning very abnormally are gradually operating more normally, ECB President Jean-Claude Trichet said in an interview on France's Europe 1 radio.
He rejected a warning by ECB governing council member Axel Weber, head of Germany's influential Bundesbank, that the bond purchases could cause inflation.
All the liquidity that is being injected in through these interventions will be taken back. We are not printing money. Our objective is price stability in the medium and long term, Trichet said.
ECB executive board member Juergen Stark said euro zone central banks would hold the government bonds they bought until maturity, and the ECB would resist any political pressure to allow higher inflation to ease governments' debt problems. But he acknowledged other economies might take the inflation route.
Economists have said the United States and Britain may accept higher inflation to cope with their debt mountains, leaving the euro zone out of step with a tight monetary policy.
(additional reporting by Marcin Grajewski in Brussels, Crispian Balmer and Sudip Kar-Gupta in Paris, Axel Bugge, Nigel Davies and Elisabeth O'Leary in Madrid, David Stamp in Berlin; writing by Paul Taylor, editing by Elizabeth Fullerton)