EU Leaders Agree on Bank Rescue Fund, Bond Support for Italy and Spain

Posted June 29th, 2012 at 8:30 am (UTC-5)
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Leaders of the European Union have reached an agreement to use its rescue fund to directly boost struggling banks across the continent, and to seek a tighter long-term budgetary and political union.

The decision was reached early Friday after hours of discussions at the EU summit in Brussels. The agreement establishes a joint banking supervisory body for the 17-nation bloc that uses the euro currency, and allows the rescue fund to buy bonds of distressed borrowers. That element of the agreement was included to satisfy demands of Spain and Italy, which wanted help to ease rising borrowing costs.

The EU leaders also agreed to set aside about $150 billion to stimulate growth in the bloc's weakest economies. The so-called “growth pact” was initially rejected by Spain and Italy, which held out until their demands were agreed to.

Global markets reacted positively to the plan in early Friday trading. The euro rose sharply against the U.S. dollar, while long-term interest rates on bonds issued by Spain and Italy dropped by several basis points.

European Council President Herman van Rompuy hailed the agreement after the meeting.

“We agreed on something new which is a breakthrough that the banks can be recapitalized directly in certain circumstances and the biggest of the most important condition is that we have to put in place a single supervisory mechanism and second decision is that we are opening the possibilities to countries who are well behaving, that we are opening the possibilities to make use of financial stability instruments ESFS, ESM in order to reassure markets.''

Madrid was offered $125 billion from the bailout fund to boost its struggling banks, a move that would have placed the loan on the government's books and increased Spain's sovereign debt. The terms of the loans sent Spain and Italy's interest rate on their loans soaring to near 7 percent, the same level at which smaller EU economies such as Greece, Ireland and Portugal were forced to secure international bailouts in the last two years.

Friday's agreement on the direct bank loans marked a change of attitude for eurozone economic leader Germany, which had been insisting that countries impose severe austerity measures in exchange for the loans. But German Chancellor Angela Merkel told reporters early Friday that she was pleased with the new approach.

“Performance and rewards, conditionality and control, in that sense I believe I have done something important, but we stuck to our philosophy of performance and rewards.''

French President Francois Hollande, who has led the push within the EU on switching the focus from austerity to growth, is also expressing support for the new agreements.

“We achieved those two objectives. Act efficiently straight away, and at the same time know what we want to do together, and finally put growth measures in place. So I think, we'll see, the summit has not finished, and on the three objectives I decided on – growth, short-term measures, a joint vision for the future – we made important steps yesterday and last night.''

Some European leaders are advocating the sale of eurobonds, debt supported by the entire 17-nation eurozone, not just individual governments. But Berlin has opposed their adoption, fearing that its borrowing costs could jump even as those for weaker governments drop.