Euro zone leaders early this morning opened the door for the immediate creation of a permanent rescue fund for distressed euro countries and for the European Central Bank to buy government bonds.
At a summit last night, they directed the European Commission to produce proposals this weekend which the governments of the 16 euro zone countries hope to endorse at an emergency meeting of finance ministers tomorrow.
“The hour of truth has struck for the euro zone,” French president Nicolas Sarkozy said moments after the four-hour meeting in Brussels broke up.
After a fresh wave of turmoil ripped through global markets yesterday, the euro governments agreed to step up their efforts to fight sovereign debt “contagion” as ECB chief Jean-Claude Trichet and Commission chief Jose Manuel Barroso each warned that the single currency is in the grip of a “systemic problems” due to Greece’s debt crisis.
The leaders said that they “fully support” the ECB in its action to ensure the euro area’s stability.
“Everyone in the euro area is totally supportive of our currency, will defend the currency obviously and we fully support the ECB in what it is doing in that respect,” Taoiseach Brian Cowen told reporters.
"We will defend the euro whatever it takes. We have several instruments at our disposal and we will use them," European Commission president Jose Manuel Barroso said after the summit. He declined to give any details of the proposals, which will be presented to all 27 European Union finance ministers for approval tomorrow.
Financial markets have been hitting euro zone countries with high deficits or debts as well as low economic growth, threatening to force Portugal, Spain and Ireland into a position where, like Greece, they would need to seek financial aid.
Euro zone leaders, who have been accused of heightening market uncertainty with a lack of action, agreed in the face of rising market concern to accelerate budget cuts and ensure budget deficit targets are met this year.
They agreed to sharpen EU budget rules and have more effective sanctions for rule-breakers, and to pay close attention to debt levels and competitiveness.
They agreed they faces an extraordinary situation after giving their political approval to an EU-IMF deal to release €110 billion to Greece over three years.
They said they fully supported the European Central Bank in its actions to safeguard the stability of the euro zone. The leaders' statement said all euro area institutions, including the ECB, would use the "full range of means available to ensure the stability of the euro area."
Asked whether the ECB was ready to buy bonds that need financial support, Mr Barroso said he would not tell the ECB what to do. EU president Herman Van Rompuy said all euro zone institutions agreed "to use the full range of means available to ensure the stability of the euro area."
"It is a time of emergency," an Italian spokesman quoted Italian prime minister Silvio Berlusconi as saying during the meeting.
Fears that the emergency loans might not be enough to prevent a Greek default and avert a broader economic crisis kept world stocks near a three-month low, despite strong US jobs data.
Group of Seven finance ministers discussed the situation in a conference call after US Federal Reserve officials expressed concern, and agreed to keep a close eye on the markets.
President Barack Obama told German chancellor Angela Merkel by telephone that he backed efforts to rescue Greece and said regulatory agencies were investigating an "unusual" sudden drop on US markets on Thursday.
"We agreed on the importance of a strong policy response by the affected countries and a strong financial response from the international community," Mr Obama said.
Despite broad agreement on the need to tighten budget discipline, the euro zone leaders found agreement elusive on a crisis mechanism to protect other countries.
"This is a systemic problem. It's a question of the stability of the euro," one EU official quoted ECB President Jean-Claude Trichet as saying during the meeting.
Ms Merkel, who presides over Europe's largest economy and has often been at odds with other EU leaders because of German public opposition to helping Greece, said she would not rule out reform of union treaties to tighten budget rules.
Other EU leaders have resisted such changes and the union has struggled for unity during the crisis, leading to accusations that its hesitancy has increased the uncertainty on the jittery financial markets.
Hours before the meeting, the German parliament approved its share of the Greek rescue, the largest contribution by a euro zone country. The Dutch parliament also approved its part of the deal and Italy's cabinet has given initial approval.
Germany's highest court today rejected a request from a group of academics to block the immediate release of a German loan to Greece. The academics, reflecting widespread German public opposition to the measure, argued that the financial aid was not provided for under European Union treaties and would give rise to inflationary policies.
Greece's parliament backed an austerity plan on Thursday but selling accelerated across markets after the ECB said it had not considered buying government bonds to ease Greece's debt crisis.
Greece's €30 billion austerity bill imposes years of hard measures in return for the joint rescue by the EU and IMF, and has led to violent protests in Athens.