Germany moves to dampen hopes of crisis resolution

Germany lowered expectations of a breakthrough in the euro zone's sovereign debt crisis next weekend, saying Sunday's EU summit will not produce a final solution, and kept up pressure on banks to accept bigger writedowns on Greek debt.

Financial markets have risen in the last week on hopes that the 27 European Union leaders will agree on a comprehensive plan to draw a line under the two-year-old crisis, which is weighing on the world economy.

But German finance minister Wolfgang Schäuble said in a speech in Dusseldorf today that while European governments would adopt a five-point platform to address the turmoil, it was wrong to expect "a definitive solution" at the summit.

Mr Schäuble said the plan would have to include a reduction in Greece's debt mountain. He repeated at the weekend that private bondholders would have to accept steeper voluntary write-downs on their Greek holdings than the 21 per cent agreed last July.

A lead negotiator for the banks said this could only happen if policymakers addressed the "full range" of sovereign debt issues in Europe. Charles Dallara of the Institute of International Finance (IIF) declined comment on reports that the private sector might have to take a 50 per cent loss.

This afternoon, Mr Schäuble raised questions that Greece's sovereign debt may need further restructuring,

In remarks at Chatham House in London today, Mr Schäuble also said he is unsure if the EU will agree to tax financial transactions across the region. "Pressure is increasing" to impose such a levy, and other regions will follow if Europe leads the way, Mr Schäuble said this afternoon. Global protests against the financial industry show that a transaction tax can foster "peace", he said.

The euro rose to a new one-month high today against the dollar and European shares hit a 10-week peak on optimism about the October 23rd summit, which G20 finance chiefs called a decisive moment. But European stocks gave back some gains and German bonds rose after Mr Schäuble's remarks.

Meeting those high expectations will be difficult. Euro zone leaders are in a race against time to convince banks to accept "voluntary" writedowns of up to 50 per cent on their Greek debt. They are also trying to agree on a blueprint for recapitalising financial institutions at risk from the deepening crisis.

"Determining how the writedowns will be applied and the source of funds to recapitalise the banks will require arduous negotiations between now and the deadlines the EU has set for itself," said Dan Morris, global strategist at JP Morgan Asset Management.

"We remain optimistic an agreement will be found but returns have been so strong over the last few weeks there is a risk of disappointment if it takes longer to work out the details than investors expect."

Pre-summit talks are taking place amid renewed social unrest in Greece. Much of the country is expected to be shut down by a 48-hour strike that will peak on Thursday, just as parliament votes on controversial new austerity measures.

German chancellor Angela Merkel's spokesman said the government was working "intensively" to define how German banks would participate in a second rescue package for Greece and how to make best use of the the region's €440 billion rescue fund, the European Financial Stability Facility (EFSF).

Leaders hoped to take a "big step" forward in addressing the crisis, Steffen Seibert said, warning that expectations for the summit had gotten out of hand.  "The chancellor has pointed out that the dreams building up that this package will mean everything will be solved and over by Monday cannot be fulfilled,"  he said.

Mrs Merkel and French president Nicolas Sarkozy promised last week that they would unveil a new comprehensive plan by the end of the month, boosting investor hopes.

The IIF said private holders of Greek bonds were prepared to discuss changes in how they might participate in future Greek debt relief.

EU officials say the bankers have little choice, since the alternative would be a disorderly default that would trigger wider financial market chaos and bigger losses.

One solution under discussion is leveraging the EFSF to give it more firepower, but it is unclear whether a solution can be found that satisfies Germany and other northern European members of the currency area.

Agencies