Euro zone ministers struggled to reassure financial markets on Tuesday that an aid package for Spain they outlined overnight will help stabilise the currency bloc - a task made all the harder by a German legal challenge to its crisis-fighting tools.
The ministers agreed early on Tuesday to grant Madrid an extra year until 2014 to reach its deficit reduction targets in exchange for further budget savings. They also set the parameters of an aid package for Spains ailing banks.
The decisions were aimed at preventing the currency area's fourth largest economy, mired in a worsening recession, from needing a full state bailout which would stretch the limits of Europe's rescue fund and plunge it deeper into a debt crisis.
"There's no emergency here, there's a clear path towards stabilisation," Luxembourg Finance Minister Luc Frieden said of the measures agreed for Spain. "The markets have to realise that the money is there, more money than is necessary."
But markets were disappointed the meeting did not offer more. The euro initially traded near a two-year trough against the dollar and hit a five-week low versus the yen, with sentiment edgy as the focus shifted to a German court hearing.
Germany's top court also will pick up the issue on Tuesday about whether Europe's new bailout fund and budget rules are compatible with national law in a process influencing not just how to tackle the euro zone crisis, but how much deeper European integration can go.
The hearing into complaints about the fund, the European Stability Mechanism (ESM), and fiscal pact may indicate how long the court will keep Europe on tenterhooks.
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Anything more than a few weeks would mean a serious delay to implementing the ESM, which has already been postponed from July 1, and raise serious doubts about whether Europe will really get the extra firepower it needs to combat the crisis.
"A considerable postponement of the ESM (bailout fund) which was foreseen for July this year could cause considerable further uncertainty on markets beyond Germany and a considerable loss of trust in the euro zone's ability to make necessary decisions in an appropriate timeframe," German Finance Minister Wolfgang Schaeuble told the court/
At their meeting overnight, euro zone finance ministers did not agree a final figure for aid to ailing Spanish lenders, weighed down by bad debts due to a housing crash and recession, but the EU has set a maximum of 100 billion euros and some 30 billion euros would be available by the end of July if there was an urgent need.
A final loan agreement will be signed on or around July 20, Eurogroup chairman Jean-Claude Juncker told a news conference.
Frieden, arriving for Tuesday's meeting of finance ministers from the broader 27-member European Union, said the 100 billion euros available to Spanish banks was much more than they needed.
In one key decision watched by investors, ministers agreed overnight that once a single European banking supervisor is set up next year, Spanish banks could be directly recapitalised from the euro zone rescue fund without requiring a state guarantee.
That fulfils an EU summit mandate to try to break a so-called "doom loop" of mutual dependency between weak banks and over indebted sovereigns, but represented a climbdown for hardline north European creditor countries.
"It is a very, very positive agreement," Spanish Economy Minister Luis de Guindos said on arrival for Tuesday's meeting.
KEY APPOINTMENTS
In a nine-hour marathon meeting ministers of the 17-nation euro zone also settled a series of long delayed appointments.
But they made no apparent progress on activating the bloc's rescue funds to intervene in bond markets to bring down the spiralling borrowing costs of Spain and Italy, which threaten to drive them out of the market.
The ministers reappointed Juncker as their chairman for a further term of up to 2-1/2 years, though Europe's longest-serving government leader said he intended to step down from the position at the end of this year or early in 2013.
They nominated another Luxembourger, inflation hawk Yves Mersch, to the vacant position on the European Central Bank's six-member executive board, and picked German Klaus Regling to head their permanent bailout fund, the European Stability Mechanism, due to come into force this month.
Regling had already set up and run the temporary European Financial Stability Facility which has funded rescues for Greece, Ireland and Portugal.
The Eurogroup ministers were tasked with fleshing out a bare-bones agreement reached by EU leaders at a summit last month on establishing a European banking supervisor and using the bloc's rescue funds to stabilise bond markets.
But differences persisted between north European countries such as Finland and the Netherlands and southern states led by Italy and Spain.
On Monday, ECB President Mario Draghi endured at times hostile questioning in the European Parliament, notably from German, Dutch and Finnish lawmakers concerned at the prospect of European bank bailouts using taxpayers' money.
Tuesday's meeting will formally ease a deficit reduction goal that has forced Madrid to make punishing cuts that are exacerbating a recession.
SLIPPAGE
Spanish and Italian borrowing costs eased on Tuesday, with Spain's 10-year bond dipping back below the critical 7 percent level.
Spain's de Guindos spelled out to the euro zone ministers on Monday his government's plan for a package of up to 30 billion euros over several years through spending cuts and tax hikes that are due to be announced this Wednesday.
A source close to the Spanish government said 10 billion euros of cuts would come this year and that the measures would include a hike in VAT sales tax, reduced social security payments, reduced unemployment benefits and changes to pensions calculations.
The European Commission proposed in return easing Madrid's deficit goal for this year to 6.3 percent of economic output, 4.5 percent for 2013 and 2.8 percent for 2014.
European Economic and Monetary Affairs Commissioner Olli Rehn said Spain was expected to take additional savings measures very soon to ensure it meets its new targets.
The new targets may still prove hard to reach, according to a draft recommendation from European partners, loosening Spain's goals and demanding the country be subjected to three-monthly checks.
The figures highlighted Spain's dramatic fiscal slippage due to a worsening recession. Madrid was originally meant to cut its budget shortfall to 4.4 percent this year. Prime Minister Mariano Rajoy unilaterally changed the target to 5.8 percent in March before eventually accepting an agreed goal of 5.3 percent.
Ministers sought to project confidence in Spain.
"We are confident that Spain is (doing) and will do all that is necessary to overcome this crisis," said Dutch Finance Minister Jan Kees de Jager.