Germany and France have reached a consensus on steps to boost economic co-ordination within the eurozone as part of a comprehensive anti-crisis package that will also see the scope of Europe's bailout fund bolstered. German officials said on Wednesday that Chancellor Angela Merkel and French President Nicolas Sarkozy would present joint proposals to strengthen policy co-ordination in the 17-nation bloc at an EU summit in Brussels on Friday.
German Deputy Finance Minister Joerg Asmussen sent the strongest signal yet that Berlin was prepared to give new powers to the eurozone's rescue fund in exchange for fiscal discipline commitments by other euro members. "We have always said that we would do all that is necessary to defend the stability of the euro zone as a whole," Asmussen told a conference in Frankfurt. "That might include revising the scope and efficiency of the EFSF," he said, referring to the 440 billion euro ($609 billion) European Financial Stability Facility.
No final agreement on a new strategy for combating the eurozone's sovereign debt crisis is expected before a March 24-25 summit, but markets are already welcoming signs that European leaders are zeroing in on a deal to stem contagion from Greece and Ireland to vulnerable countries like Portugal and Spain.
The euro has gained 7 percent on the dollar in the past three weeks to trade above $1.38 for the first time since early November. The risk premiums on Spanish and Greek 10-year bonds are at a three-month low. Even the spreads betwen Irish bonds and German benchmarks narrowed on Wednesday on relief that a ratings downgrade from Standard & Poor's was not deeper. Long seen as the motor behind European integration, Germany and France struggled last year to forge consensus on how to tackle the worst crisis in the single currency's 12-year existence, stoking fears the bloc could break apart.
But Merkel and Sarkozy have overcome their differences in recent weeks to forge the rough blueprint of a "grand bargain" between French demands for closer economic co-ordination in the eurozone and Germany's push for more fiscal discipline. Euro zone countries would pledge to enshrine German-style deficit and debt limits in their national legislation, tie their pensions policies to demographic factors and move towards a harmonisation of corporate tax and labour policies under a draft seen by Reuters last week.
French government spokesman Francois Baroin said Paris and Berlin were in constant contact on the negotiations but did not mention any joint proposal. In an apparent nod to Berlin, France announced on Wednesday that it would reform its constitution to include a "golden rule" on balancing the budget. "This is a reshaping of our constitution which will fix a clear objective of budgetary equilibrium and will see the means of achieving it," Budget Minister Francois Baroin said.
In exchange for other European partners agreeing, Germany appears ready to meet the demands of other euro members that the EFSF be given additional powers. Set up in May after the shock bailout of Greece, the fund has a headline number of 440 billion euros but for technical reasons can only lend about 250 billion euros. Germany now seems ready to boost its effective lending capacity to the full 440 billion euros and possibly allow it to lend to vulnerable countries like Greece so that they can repurchase their bonds at a discount.
Euro zone sources in Brussels said governments of the currency bloc were also seriously considering letting the EFSF buy bonds of distressed governments on the primary market, when they are auctioned by the issuing country. A senior German official told Reuters that Berlin was coming around to the idea of reducing the interest rate the EU is charging Greece for the loans in its 110 billion euro bailout and extending the period over which those loans must be repaid - although an extension to 30 years is seen as unlikely.