EU leaders' latest agreement still leaves unfinished work

BRUSSELS, Belgium -- After all the hype about the do-or-die talks to save the euro, there was a strange absence of urgency about the latest summit of European Union leaders.

The two-day meeting that ended Friday produced no silver bullet to end the euro-crisis and left out some critical details that may require future summits to resolve.

Stocks and the euro rose on the news, despite the deep rift which emerged between Britain and the other EU members and the summit's lack of any clear signal on central bank intervention to save the euro, which many had considered essential to restore confidence in the common currency.

Central to what the summit did decide is the creation of a new "fiscal compact" among the 17 eurozone nations and up to nine of the other EU members. Only Britain, which doesn't use the euro, said it would stay out.

The plan will involve unprecedented oversight of national economies by the EU with sanctions for governments that run up high deficits as part of a German-inspired drive to restore market confidence in eurozone nations' debt and prevent a repeat of the current debt crisis.

"This is a breakthrough toward a union of stability. The fiscal union will be developed step by step," German Chancellor Angela Merkel told reporters after the talks. "We will use the crisis as a chance for a new beginning."

British Prime Minister David Cameron vetoed Germany's call for a new EU-wide treaty on the tough new fiscal rules. Under pressure from the powerful euro-skeptic wing of his Conservative Party, Cameron refused to hand over more sovereignty to Brussels and demanded guarantees to shield the City of London financial district from EU regulation - galling the other leaders.

"London would get an advantageous competitive position above Amsterdam, Luxembourg, Paris and Frankfurt, and that's going too far," said Dutch Prime Minister Mark Rutte.

The new economic measures should be written into a new treaty to be concluded by March without Britain. Under the deal, nations will make a constitutional commitment to balanced budgets with a structural deficit of less than 0.5% of gross domestic product. Many European countries have run much higher deficits since the 2008 financial crisis and the agreement allows deficit caps to be broken during recessions.

Those that break deficit rules will face sanctions. Struggling euro-zone members will be obliged to summit national budgets to EU authorities for approval.

"We are committed to working towards a common economic policy," the eurozone leaders said in a statement. "All major economic policy reforms planned by euro-area member states will be discussed and coordinated."

Markets had been hoping that such an agreement on fiscal discipline would lead Merkel to relax opposition to the European Central Bank intervening on bond markets as a lender of last resort to key euro-zone nations like Italy and Spain. However, there was no such signal from Merkel or the other leaders.

In fact, ECB President Mario Draghi on Thursday dampened hopes that the Frankfurt-based bank would intervene massively on the primary market to ease nations' debts either directly or via loans to the International Monetary Fund. Draghi suggested that would violate the EU's current treaty. He said the EU's principle bulwark in defense of cash-strapped governments should be the two special funds which leaders agreed to set up in response to the crisis.

At the summit, the leaders agreed to bring forward by a year the creation of 500 billion euro ($669 billion) European Stability Mechanism so it should be ready by July 2012. The leaders also made the decision-making process of the ESM more flexible so it can react quickly in emergencies.

Other measures included guarantees that so-called financial "haircuts" imposed on private lenders to Greece to ensure banks share the bailout burden won't be repeated for other countries. Ensuring that government bondholders won't lose money on future bailouts should increase markets' confidence in buying struggling nations' bonds.

They agreed to augment the resources of the IMF by 200 billion euro ($268 billion) in bilateral loans to ensure it has enough resources to intervene again in the euro crisis if needed — an effective support from richer EU nations to those in trouble.

Leaders also called for a rapid leveraging of the EFSF from its original 440 billion euro ($588 billion). However efforts to boost the funds firepower to 1 trillion euro ($1.3 trillion) announced at the last EU summit in October have so far fallen short and many economists doubt that the facility will ever reach the levels needed to assure markets that Italy and Spain are protected.

"The EFSF and the ESM will help, they are another bullet that can be used, but in the end these are limited mechanisms and the market knows that," cautioned Fabian Zuleeg, chief economist at the European Policy Center, a Brussels-based think tank. "It's difficult to see a route out of the immediate crisis that doesn't involve the ECB, we have to go back to the question of an ultimate back stop."

The ECB on Thursday did provide some relief to Europe's cash-starved banks by offering three-year loans and cutting interest rates back to a record low of 1% in an effort to counter the impact of the economic slump.

Although the summit fell short of many expectations, the market reaction was positive, helped by a Reuters report that China's central bank plans to create a new vehicle to manage two investment funds worth a total of $300 billion targeting the United States and Europe.

European leaders will be hoping that their commitment to fiscal discipline and the limited boost to their defense mechanism will keep the markets' calm even with the lack of ECB action and the threat of credit agency downgrades hanging over the euro-zone economies.

Much will depend on the EU's ability to leverage the EFSF and to clarify how the new fiscal compact will be policed.

"They have not found all the answers, the European summit did not do enough," said Zuleeg. "There was no conclusion on the greater role of the ECB and the long-term challenges have not been addressed — sooner or later they are going to have to address the long-term growth problems."