A European summit deal to strengthen budget discipline in the eurozone failed to restore financial market confidence on Monday, forcing the European Central Bank to step in again gingerly. The euro fell, stocks slid and borrowing costs for Italy and Spain rose as investors weighed the outcome of last week's summit that split the European Union, with Britain blocking treaty change and forcing eurozone countries to negotiate a fiscal accord outside the Union.
---- EU summit fails to lift European markets
---- Sarkozy sees birth of new sort of Europe
---- Italian, Spanish borrowing costs rise
---- ECB slashed bond purchases before summit
Friday's initial market rally petered out in less than 24 trading hours due to legal uncertainty surrounding the new pact and the absence of an unlimited financial backstop for the single currency. French President Nicolas Sarkozy said the legal basis of a new accord to enforce debt and deficit rules in the 17-nation euro area with quasi-automatic sanctions and intrusive powers to reject national budgets would be worked out before Christmas.
"In the next fortnight, we will put together the legal content of our agreement. The aim is to have a treaty by March," Sarkozy told newspaper Le Monde in an interview. An EU diplomat said the first draft of the new treaty would be ready by early next week. Sarkozy said the aim was to have it ratified by all member states except Britain by June.
In the Le Monde interview, Sarkozy prepared French voters for a possible downgrade of the country's AAA credit rating but insisted he could cut the public deficit without cutting salaries and pensions.
Traders said the ECB intervened to buy short-term Italian debt after yields on Italian and Spanish debt spiked. The central bank revealed on Monday it had slashed bond purchases in the week before the EU summit as it raised pressure on the bloc's leaders to introduce tighter debt controls and make further public spending cuts. It bought just 635 million euros in bonds in the week to December 9 compared to 3.66 billion the previous week.
ECB sources told Reuters on Friday purchases would remain limited with a maximum ceiling of 20 billion euros a week. There is no prospect of a "big bazooka" to shock markets. Italian 5-year bond yields shot up above 7 percent, widely seen as a danger level while 10-year yields spiked above 6.8 percent and Spanish 10-year yields topped 6 percent.
Investors' appetite for short-term paper drove Italian one-year borrowing costs down just below 6 percent at an auction but yields remain uncomfortably high. "Let's not raise expectations too high, there will be more summits," credit ratings agency Standard & Poor's chief European economist Jean-Michel Six said.
S&P has put 14 eurozone governments on watch for a possible rating downgrade in the coming weeks, arguing that the deepening debt crisis and looming recession will increase their potential liabilities and reduce their ability to cope with them. If some of the eurozone's AAA-rated members are downgraded, it would call into question the solidity of the eurozone's rescue fund, which would likely suffer a similar fate.
Cameron was given a hero's welcome by Eurosceptics in his Conservative party but faced a backlash from his Liberal Democrat coalition allies when he explains a veto that has cast Britain adrift from its continental partners. "Britain remains a full member of the EU and the events of the last week do nothing to change that," Cameron insisted in parliament.
In a defiant statement, he told lawmakers he made no apology for having demanded safeguards for the City of London financial centre in any new EU treaty, but said Britain's interests remained fully protected by its membership of the single market. In Brussels, officials were groping for a strong legal basis for the planned fiscal compact, with Britain arguing that the eurozone cannot use the EU treaty institutions - the European Commission and the European Court of Justice European Economic and Monetary Affairs Commissioner Olli Rehn said most of the practical measures to strengthen budget enforcement could be implemented immediately under a set of rules known as the "six-pack" agreed in October.