Euro zone enters a decisive week

The euro faces a decisive week as European Union leaders, urged on anxiously by the United States, seek agreement on the definitive rescue plan that has eluded them for two years.

Despite short-term market optimism about a possible deal to tackle Europe's sovereign debt crisis and ensure the survival of the single currency, the outcome is far from certain as the EU gears up for a summit in Brussels on Thursday and Friday.

"This week, the stable future of the euro and thus the economic recovery in Europe and employment are at stake," EU Economic and Monetary Affairs Commissioner Olli Rehn told Reuters. "This calls for a convincing package of measures from the European Council (summit)."

If all goes according to plans being hatched in Berlin and Paris, the EU will have taken a step towards fiscal union by Friday night, agreeing on a treaty change to anchor coercive budget discipline for the 17-nation currency area.

The European Central Bank will have cut interest rates on Thursday to counter a looming recession and taken new measures to provide longer-term funding for Europe's teetering banks.

And new prime ministers in Italy, Greece and Spain will have demonstrated their commitment to tough austerity measures and structural economic reforms to tackle their debt problems and restore investor confidence.

World financial markets rallied last week on the prospect of such a masterplan after ECB chief Mario Draghi signaled that in response to a new "fiscal compact" in the euro zone, the central bank could act more decisively to fight the crisis.

A convincing show of political determination to stand behind the euro and surmount the crisis through closer euro zone integration could prompt the ECB to do more to support Italian and Spanish bonds, cementing that reversal of market sentiment.

"It all comes down to what the ECB does, and whether political leaders produce a sufficiently convincing plan to give the ECB a basis to intervene," a senior EU government source said, speaking on condition of anonymity to respect the independence of the central bank.

However, if the 27-nation EU is unable to agree, or settles for another half-measure after months of dithering, the flight from euro zone bond markets may accelerate, confidence may ebb further and the crisis could become acute in January, when Italy has to start a massive refinancing campaign.

MERKEL PERMISSIVE?

Underlining Washington's vital interest in averting a euro zone meltdown, U.S. Treasury Secretary Timothy Geithner will visit Frankfurt, Berlin, Paris, Marseille and Milan from Tuesday to urge key European officials to take decisive action.

Sources close to German Chancellor Angela Merkel say she is prepared -- despite hostility from the German Bundesbank -- to see the ECB step up buying of troubled states' bonds as a short-term bridging measure until stricter euro zone budget controls take hold.

But things may not go entirely according to plan.

Merkel visits French President Nicolas Sarkozy in Paris on Monday to outline joint proposals on economic governance, but Berlin and Paris still have significant differences about how the euro zone would control national budgets.

Merkel wants to empower the executive European Commission to veto national budget plans that breach EU limits before they go to parliament, with automatic sanctions for deficit sinners and the possibility to take serial offenders to the European Court of Justice for punishment.

Sarkozy, struggling to win re-election next May, wants euro zone leaders to have the final say, with no new supranational powers for EU institutions.

Several other governments, notably Britain, Ireland and the Netherlands, do not want treaty change at all because of the domestic political risks. Some fear it would be hard to win public backing in referendums.

European Council President Herman Van Rompuy, who chairs the crucial end-of-week summit in Brussels, will present options for stricter budget control without touching the treaty, as well as steps that would require amendments, aides said.

European Parliament President Jerzy Buzek warned last Friday that treaty change could be divisive and "dangerous." But diplomats say it is a political must for Merkel.

For British Prime Minister David Cameron, the choice is between enraging eurosceptics at home by allowing treaty change to go ahead without winning a return of key powers to London, or seeing the 17 euro zone states reach a separate agreement outside the treaty that could cement a two-speed Europe.

SHORT-CIRCUIT

Germany and France want to short-circuit the complex treaty amendment procedure by wrapping the new budget procedures into a single amended protocol 14 on the euro zone. They hope to avoid a parliamentary convention and spare most, if not all, countries the need for a referendum on ratification.

That has caused outrage among some lawmakers who say the EU's main powers are trying to sideline national parliamentary budget sovereignty without any democratic accountability.

In their defense, Paris and Berlin argue the debt crisis is an emergency that requires swift executive action to avert disaster, and that member states already signed up to the budget rules in the 1992 Maastricht Treaty.

While Sarkozy and Merkel put forward their plan, new Italian Prime Minister Mario Monti will be unveiling rigorous austerity measures and economic reforms designed to save Rome from requiring the next international bailout. And bailed-out Ireland will be presenting an eye-watering 2012 austerity budget.

Italy has become the centre of the debt crisis since yields on its 10-year bonds shot up above 7 percent, levels at which Greece, Ireland and Portugal were forced to seek EU/IMF help.

Government sources familiar with Monti's plan say the mix of cuts and tax rises will total 20-25 billion euros ($27-34 billion) over two years. About half will go to reduce the(...)More.