Euro zone finance ministers agreed on Friday to raise their financial firewall to prevent a new flare-up of Europe's sovereign debt crisis, but it was unclear if markets and Europe's G20 partners would see the boost as sufficient.
The 17-nation currency area agreed to combine its two rescue funds to make 500 billion euros of new funds available in case of emergency until mid-2013, on top of 200 billion euros already committed to bailouts for Greece, Ireland and Portugal.
The executive European Commission had proposed raising the total amount to 940 billion euros, of which 740 billion would have been as yet uncommitted funds, but EU paymaster Germany resisted a higher number.
Initial market reaction was positive, with the yields on Spanish bonds falling as investors weighed the ministers' decision and awaited a draconian Spanish austerity budget.
"Today's decision is a classic European compromise. It was as far as the German government was willing to go and it was the minimum most other euro zone countries were expecting," said Carsten Brzeski, economist at ING bank in Brussels.
"Obviously, a bigger increase along the lines of earlier discussed options could have sent a stronger signal and would have been more convincing," he said.
"With today's increase, the role of the ECB (European Central Bank) as Eurozone fire brigade is likely to continue."
An official statement said ministers had lifted the combined lending capacity of the temporary European Financial Stability Facility (EFSF) and the permanent European Stability Mechanism (ESM) to 700 billion euros from 500 billion.
"The current overall ceiling for ESM/EFSF lending ... will be raised to 700 billion euros," it said. "All together, the euro area is mobilising an overall firewall of approximately 800 billion euros, more than 1 trillion dollars."
However, the highest headline number included money already disbursed from the EFSF, a smaller bailout fund controlled by the European Commission and bilateral loans which euro zone countries extended to Greece under the first bailout.
The 500 billion in fresh lending capacity for the combined funds until July 2013 takes account of the fact that the ESM will not start its operations at full capacity, but only grow into it as capital is paid in over three years.
It means 240 billion of uncommitted funds in the EFSF could be tapped if necessary until the ESM becomes bigger.
French Finance Minister Francois Baroin said the decision gave Europe a stronger hand to persuade other major economies to increase the International Monetary Fund's resources to fight contagion from the euro zone crisis if necessary.
"We are now in a strong position for discussion on the IMF in April. It is a good signal," Baroin said.
Some bond market players questioned whether the compromise would provide sufficient money to help Spain, the euro zone's number four economy, if it needs a bailout to overcome a banking crisis due to the collapse of a real estate bubble.
"At the end of the day the key question is whether this new firepower is enough," said Steve Barrow, head of G10 strategy at Standard Bank in London. "Clearly if things turn down again, and especially if more bailouts are needed, the tricky issue of underfunding the ESM/EFSF relative to the potential bailout need is bound to resurface."
After tempers flared, Eurogroup chairman Jean-Claude Juncker called off a scheduled news conference, saying Austrian Finance Minister Maria Fekter had already announced the outcome.
Juncker said the appointment of a new European Central Bank executive board member had been postponed until mid-April. He had earlier said fellow Luxembourger Yves Mersch was the strongest candidate for the ECB job.
The delay may have been due France's request to hold off on choosing a successor to Juncker as Eurogroup chairman until after the April-May French presidential election.
Diplomats said French President Nicolas Sarkozy wanted to avoid political embarrassment from the likely choice of German Finance Minister Wolfgang Schaeuble, which his opponents could portray as a sign of German dominance in the euro zone.
Commerzbank analyst Christoph Weil said the firewall boost, combined with extra assistance from the IMF, would probably be big enough to "offer shelter to Spain and Italy if necessary".
"Nonetheless, there is reason to fear that investors will remain sceptical and continue to demand high risk premiums for peripheral bonds," he wrote in a note.
Spanish austerity
Countries sharing the euro have already agreed to adopt more strictly enforced balanced-budget rules in an effort to convince markets that their public finances will be sustainable.
They also agreed to slap fines on countries that run excessive budget deficits or have large imbalances in their economies.
Spain, which has rejected all talk of seeking assistance, was set to unveil a tough austerity budget on Friday designed to reduce its public deficit to 5.3 percent of gross domestic product this year from 8.5 percent in 2011 despite a recession.
"This is a budget that will be convincing, I am sure of that, and show the Spanish government's commitment to austerity and fiscal consolidation," Economy Minister Luis de Guindos said in Copenhagen.
He played down a general strike and mass street protests on Thursday that highlighted the scale of opposition to a new labour law making it easier to fire workers and dismantling collective wage bargaining. Hundreds of thousands of Spaniards marched in protest, with violence flaring in Barcelona.
Spanish bond yields rose again amid market doubts about Madrid's ability to implement reforms and repair public finances threatened by the recession and the banking crisis, at a time when unemployment is already 23 percent, the highest in the EU.
After a deal with investors this month to restructure Greek debt, increasing the amount of money the euro zone can provide to help members cut off from markets is seen as the next step to boost investor confidence.
In another move to ease the immediate crisis, Ireland managed to avoid a 3.1 billion euro payment to one of its failed banks, settling the bill by issuing a 13-year bond, Finance Minister Michael Noonan announced on Thursday.
Condition for more money for the IMF
The European Commission and several of the world's biggest economies have been pushing to increase the euro zone bailout capacity as much as possible, in the belief that once investors see a wall of money supporting euro zone debt, confidence would return and the rescue funds would never have to be used.
But Germany, where public opinion is hostile to bailouts, has been against raising the contingency funds, noting that markets have calmed down from the peak of the debt crisis.
Yet market concern about Spain, which badly missed its budget deficit target in 2011 and negotiated with the euro zone a softer target for 2012, have put the bailout capability discussion back on the table.
A higher euro zone bailout capacity is a pre-condition for most G20 countries to contribute more money to the IMF.
Euro zone diplomats are confident that the proposed temporary boost will be sufficient to unlock an additional 500 billion euros in contingency funds for the IMF.
The ministers are also to say that they will continue to review the adequacy of the ESM capital "as appropriate" and "in particular when used EFSF guarantees are freed once financial assistance is repaid".
