Eurozone Leaders OK Growth Plan, Bond Support For Italy, Spain

BRUSSELS (Reuters) - Eurozone leaders agreed on Friday to take emergency action to bring down Italy's and Spain's spiralling borrowing costs and to create a single supervisory body for euro zone banks by the end of this year, a first step towards a European banking union.

Responding to pleas from Spanish and Italian leaders, a midnight summit of the 17-nation currency area agreed that euro area rescue funds could be used to stabilize bond markets without forcing countries that comply with EU budget rules to adopt extra austerity measures or economic reforms.

After hours of argument, they also agreed that the bloc's future permanent bailout fund, the European Stability Mechanism, would be able to lend directly to recaptalize banks without increasing a country's budget deficit, and without preferential seniority status.

"The process was tough, the outcome was good," Italian Prime Minister Mario Monti told reporters, adding that Italy did not intend "at this time" to apply for the emergency support.

Countries that requested bond support from the rescue fund would have to sign a memorandum of understanding setting out their existing policy commitments and agreeing a timetable. But they would not face the intrusive oversight of a "troika" of international lenders to which Greece, Ireland, and Portugal have been subjected, Monti said.

Spain and Italy had earlier withheld their agreement to a growth package at a European Union summit to demand emergency action to bring down their spiralling borrowing costs, which threaten to force the third and fourth largest economies in the euro zone out of the capital markets.

European Council chairman Herman Van Rompuy said the aim was to create a supervisory mechanism for euro zone banks involving the European Central Bank to break the "vicious circle" of dependence between banks and sovereign governments.

"We are opening the possibility to countries that are well behaving to make use of financial stability instruments in order to reassure markets and to get again some stability around some of the sovereign bonds of our member states," Van Rompuy told a 4.30 a.m. (0230 GMT) news conference.

"The aim is of course to make the euro an irreversible project," he added.

The euro surged by 1.1 percent to $1.2581 after the euro zone affirmed its commitment to use its bailout funds more flexibly and efficiently to stabilize markets.

But whether investors regard the deal struck at the 20th summit since the crisis erupted in early 2010 as sufficient remains to be seen. Previous relief rallies have fizzled within days or hours as new doubts set in.

Monti and his Spanish counterpart, Mariano Rajoy, had refused to sign off on a 120 billion euro ($149 billion) growth package until EU paymaster Germany approved short-term measures to ease their cost of credit.

The clash highlighted tensions between northern creditor countries and heavily indebted southern states over the future shape of the troubled 17-nation currency bloc, now in the third year of a sovereign debt crisis.

German Chancellor Angela Merkel, leader of Europe's biggest economy, said she was satisfied with the result although she had dismissed any need for emergency support for Italian and Spanish bonds earlier this week.

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