European Union regulators today pushed for more budget control over euro-area nations to ease the debt crisis, heeding German demands in return for offering less creditworthy governments the prospect of joint bond sales.
Weeks after winning a year-long battle for stronger powers to sanction spendthrift euro countries, the European Commission proposed adding the right to screen national budgets earlier and monitor more closely nations such as Italy where rising borrowing costs threaten financial stability.
The commission, the EU's regulatory arm, also asked for tighter fiscal surveillance of nations such as Greece, Ireland and Portugal after they exit rescue programmes.
In exchange, the commission advanced the idea that the German government opposes of bonds sold jointly by the euro area's 17 nations by outlining three options for such debt issuance. It said two of the three options would probably involve the lengthy process of changing the EU treaty and all of them would require reinforced fiscal oversight.
The new budget-control measures are aimed at "further strengthening the surveillance mechanisms in the euro area," the commission said in a statement today in Brussels. "The global economic and financial crises have exposed shortcomings in the governance of the economic and monetary union."
Elsewhere, a "disastrous" German bond sale today sparked fears that Europe's debt crisis was even starting to threaten Berlin, however, with the leaders of the euro zone's two biggest economies still firmly at odds over a longer-term structural solution.
Investors were also unnerved by reports that Belgium is leaning on France to pay more into emergency support for failed lender Dexia under a €90 billion rescue deal that had appeared done and dusted.
A special report by Fitch Ratings suggested France had limited room left to absorb shocks to its finances like a new downturn in growth or support for banks without endangering its cherished AAA credit status.
After one of the least successful debt sales by Europe's powerhouse economy since the launch of the single currency, the euro fell to 1.336 to the dollar and European shares sank to 7-week lows.
"The debt crisis is burrowing ever deeper, like a worm, and is now reaching Germany," one of the more eurosceptic backbenchers in Angela Merkel's centre-right government, Frank Schaeffler of the Free Democrats (FDP) who are the junior coalition partners said.
The German debt agency was forced to retain almost half of a sale of €6 billion due to a shortage of bids by investors. The result pushed the cost of borrowing over 10 years for the bloc's paymaster above those for the United States for the first time since October.
"It is a complete and utter disaster," said Marc Ostwald, strategist at Monument Securities in London. The new bond promised to pay out a 2 per cent interest rate - the lowest ever on an issue of German 10-year Bunds. The auction's average yield was 1.98 percent, down from 2.09 percent for the previous benchmark in October. Ten-year Bund yields were last up 12 basis points to 2.039 per cent versus 1.946 per cent for US T-notes .
German finance minister Wolfgang Schaeuble's spokesman told a news conference that the auction did not mean the government has refinancing problems and few on financial markets disagreed.
But it was a sign that as the bloc's paymaster Germany may slowly be pressured if the crisis continues to deepen. One senior ratings agency official said it could give Berlin cause to re-examine its refusal to embrace a broader solution.
"It's quite telling that there has been upward pressure on yields in Germany - it might begin to change perceptions," David Beers of Standard & Poor's told a conference in Dublin.
The borrowing costs of almost all euro zone states, even those previously seen as safe such as France, Austria and the Netherlands, spiked in the last two weeks as panicky investors dumped paper no longer seen as risk-free.
Determined not to be pushed around by financial markets, Dr Merkel is resisting calls, most notably from France, to allow the ECB to act more decisively.
In a forceful speech to the Bundestag lower house of parliament, Merkel issued one of her starkest warnings yet against fiddling with the bank's strict inflation-fighting mandate. She also hit back at proposals from the European Commission on joint euro zone bond issuance, calling them "extraordinarily inappropriate".
"The European currency union is based, and this was a precondition for the creation of the union, on a central bank that has sole responsibility for monetary policy. This is its mandate. It is pursuing this. And we all need to be very careful about criticising the European Central Bank," Dr Merkel said.
"I am firmly convinced that the mandate of the European Central Bank cannot, absolutely cannot, be changed."
Shortly before she began speaking, French Finance Minister Francois Baroin offered a polar opposite view on the ECB's role, telling a conference in Paris that it was the central bank's responsibility to sustain activity in the currency bloc.
"The best response to avoid contagion in countries like Spain and Italy is, from the French viewpoint, an intervention (or) the possibility of intervention or announcement of intervention by a lender of last resort, which would be the European Central Bank," Mr Baroin said.
He pointed to market intervention by the US Federal Reserve, Swiss National Bank and Bank of England as a model for the ECB. But Dr Merkel said it was impossible to compare the role of the ECB, which sets monetary policy for 17 countries, with those of national central banks.
With time running out for Europe's politicians to forge a crisis plan that is seen as credible by the markets, the European Commission will present a study today of joint euro zone bonds as a way to stabilise debt markets.
Some leading European politicians, including Luxembourg Prime Minister Jean-Claude Juncker, support the bonds. But Berlin has rejected them outright as a near-term solution to the crisis, saying they would raise Germany's borrowing costs and reduce incentives for other euro zone countries to bring their fiscal houses in order.
In her speech, Dr Merkel pointed to repeated violations of the EU's Stability and Growth Pact in the currency area's first decade, saying they had damaged market faith in the bloc's ability and willingness to crack down on fiscal rule-breakers.
"And this is why I find it extraordinarily inappropriate that the European Commission is suggesting various options for euro bonds today -- as if they were saying we can overcome the shortcomings of the currency union's structure by collectivising debt. This is precisely what will not work," Dr Merkel said.
The German leader also sent a clear warning to Antonis Samaras, the leader of conservative New Democracy in Greece, who has resisted pressure to join other parties and make a written commitment to painful austerity measures.
Dr Merkel said Greece would not receive an €8 billion aid tranche it needs to avert a default next month unless Mr Samaras signed the pledge.
Dr Merkel raised pressure on the bloc to finalise plans for a "leveraging" of its rescue fund and a recapitalisation of vulnerable banks, saying guidelines were needed by the time European finance ministers meet on November 29th-30th.
"The fact that we have been talking about (bank recapitalisations) for weeks but still have no clarity is not very reassuring, and yesterday we saw with the example of one German bank how fragile the banks themselves are," Dr Merkel said.
Shares in Germany's second-biggest lender, Commerzbank, tumbled yesterday after people close to the bank told Reuters it needs considerably more capital than previously expected to meet the core capital targets demanded by the EU by mid-2012.
Agencies