A planned referendum in Ireland and a German court ruling cast new uncertainty on Tuesday over efforts to overcome the euro zone's debt crisis, just when a flood of central bank money appeared to be calming financial markets.
Ireland's prickly electorate, which has twice voted "No" to European Union treaties before reversing itself, will get another chance to keep Europe on tenterhooks with a referendum on a fiscal compact on budget discipline agreed last month.
"The Irish people will be asked for their authorisation in a referendum to ratify the European stability treaty," Prime Minister Enda Kenny told parliament after the state's top lawyer advised that on balance a plebiscite was necessary.
Kenny set no date for the vote in a country that received an EU/International Monetary Fund bailout in 2010 after suffering a banking crisis. Public support for the EU has since fallen due to the unpopularity of harsh austerity measures.
EU diplomats tried to frame the treaty to avoid the need for a referendum, which Ireland has to hold on any major transfer of power to Brussels.
Given the Irish record of anti-establishment votes on European issues, the campaign could unsettle markets even if the main establishment parties back the pact. However, unlike full EU treaties this inter-governmental accord does not require unanimity. It enters into force once 12 states have ratified it.
Germany's top court earlier overruled government efforts to push decisions on disbursing euro zone bailout funds through a special fast-track parliamentary panel meeting in secret.
That may limit Chancellor Angela Merkel's room for manoeuvre on future bailouts, which was already in doubt after a revolt by 17 lawmakers in her centre-right coalition against a second rescue package for Greece, approved on Monday.
The euro briefly dipped against the dollar on the Irish news but recovered quickly. Markets remain buoyed by the prospect of another bumper injection of cheap, three-year European Central Bank funds to banks on Wednesday.
Italy's 10-year borrowing costs fell to the lowest since last August at an auction that showed the ECB's three-year cash bonanza, combined with Rome's fiscal and economic reforms, have steadied bond markets and eased the euro zone's debt crisis.
Rights infringed
Growing public hostility in Germany to euro zone bailouts could make it harder for Merkel to agree to an increase in the currency bloc's financial firewall, which major economies are demanding as a condition for giving the IMF more money to fight the fallout from the European crisis.
However, Dutch Finance Minister Jan Kees de Jager said that a decision to increase the size of the European rescue fund may be made in April during the IMF's spring meeting.
Informal contacts had been held which would allow a decision on an IMF contribution, he told parliament. "That suggests that the one country, which has so far not made this step, may decide before that date," he said, referring to Germany's refusal so far to expand the planned European Stability Mechanism (ESM).
Two senior German conservative lawmakers said the coalition was open to discussing in March proposals to combine the current temporary EFSF euro zone rescue fund with the permanent ESM warchest to raise the safety cushion to 750 billion euros.
In a case brought by two opposition MPs, the court said a nine-member sub-committee created to approve urgent action by the bailout fund was "in large part" unconstitutional because it infringed on the rights of other deputies.
The judges said the panel may approve price-sensitive debt purchases on the secondary market by the EFSF bailout fund, since confidentiality was essential in such operations. But they denied it the power to authorise loans or preventive credit lines to troubled states or for the recapitalisation of banks.
While not a show-stopper, the decision means parliamentary deliberations on future rescue operations could be slower and more cumbersome, since the full 41-member budget committee or the entire 620-member lower house will have to decide.
Euro zone leaders have insisted that Greece is an exception and after bailouts for Portugal and Ireland, they do not expect other members of the 17-nation currency area to require assistance from their rescue fund.
Portugal passed a third compliance review by international lenders of its bailout programme on Tuesday and said it would not need a second rescue like Greece despite a deeper than forecast recession.
However, many economists say Lisbon is likely to require increased aid, and the chairman of euro zone finance ministers, Jean-Claude Juncker, has acknowledged that Athens may also need further assistance at a later stage.
Bitter measures
Greece approved bitter new austerity measures on Tuesday, slashing the minimum wage and chopping pensions as it began implementing measures demanded by the EU and IMF in return for its latest 130 billion euro rescue package.
There are concerns too about Spain, which announced on Monday that its 2011 public deficit was 8.51% of gross domestic product, far higher than the 6% target set by the European Union and above a preliminary estimate of 8.2% from the new centre-right government.
That made it even less likely, against a backdrop of recession, that Madrid will be able to reduce the deficit to 4.4% of GDP this year, as promised to the EU.
The European Commission said it was awaiting an explanation from Spain for the budget slippage and was not considering granting it any flexibility to reach this year's deficit target.
The ECB temporarily suspended the eligibility of Greek bonds for use as collateral in its funding operations and said national central banks would have to provide banks with liquidity using an emergency measure.
The move, which was expected but not so soon, was triggered by ratings agency Standard & Poor's cutting Greece's long-term ratings to "selective default" after Athens launched a bond swap to lighten its debt burden.
The swap is intended to wipe some 100 billion euros off Greece's 350 billion euro debt pile, reducing it to 120% of GDP by 2020, and forcing private debt holders to take a 53.5% loss on the face value of their bonds.
Anticipating such temporary downgrades, the euro zone and ECB had struck a deal whereby Greece would receive 35 billion euros in support from the EFSF rescue fund to enable the central bank to continue accepting Greek bonds and other assets underwritten by Athens in its lending operations. But the ECB action came before the EFSF funds have been activated.
S&P's head of European sovereign ratings, Moritz Kraemer, said the downgrading of Greece's long-term ratings to 'selective default' could well be short-lived but there was a risk Athens could fall back into default later.
"It's a distinct possibility that this will be a short default which will be cured," Kraemer told Reuters Insider television. "The more interesting question is not when it will be cured but whether it will be the last one."
When assessing what rating to give Greece in the future, S&P would look at the political environment, the growth outlook and the remaining debt stock. "We think that on all three fronts there are huge question marks," said Kraemer.
