Germany, France scale back summit ambitions

BERLIN -- German and French officials lowered expectations Wednesday for a deal to save the euro at this week's European summit, deflating investors' hopes for an imminent resolution to Europe's debt crisis.

On the same day that German Chancellor Angela Merkel and French President Nicolas Sarkozy released the details of a plan for European nations to submit their economies to tighter scrutiny, a senior German official suggested a deal could be weeks away.

The summit, which begins today, has been described as do-or-die for the 17 countries that use the euro. A growing number of eurozone economies are being dragged down by crippling debts.

Further urgency was added Wednesday after the ratings agency Standard & Poor's threatened to downgrade the bonds of all EU countries because their economies were intricately linked with those in the eurozone. That would likely make it more expensive for governments to borrow.

Earlier this week, expectations had been rising that an agreement would be reached this weekend, paving the way for the European Central Bank to take bolder action to reduce borrowing costs for Italy, Spain and other heavily indebted countries. That would give governments time to strengthen their finances.

But on Wednesday the senior German official, who spoke on condition of anonymity because talks were ongoing, said reaching a deal might take until Christmas. European stocks, which had opened the day higher, fell after the comments were made and borrowing costs for weak eurozone governments rose.

"There is a very, very strong expectation that the summit is going to be a success so there is some potential for disappointment," said Stefan Schneider, chief international economist at Deutsche Bank. "But if there is a convincing plan, which -- in contrast to some of the previous plans -- might survive the next two or three weeks, then that could support markets in the first two or three months of next year."

The proposal from Merkel and Sarkozy seeks to enforce budget discipline either through a substantial change to the treaty governing all 27 EU countries, or an entirely new treaty for the 17 countries that use the euro.

In their letter to EU President Herman Van Rompuy, Merkel and Sarkozy stressed a decision was needed at this week's meeting to have the new treaty in place by March.

"We are convinced that we need to act without delay," they wrote.

Van Rompuy offered an alternative way to secure future fiscal discipline. He favors simply amending existing rules that apply to the 17 countries that use the euro. That would allow leaders to avoid the trickier step of requiring every country to approve the new treaty through parliamentary votes.

But Merkel and Sarkozy believe that to restore lost trust in the euro currency and calm markets, Europe needs to take the more formal step, even if it's politically more difficult. Once amended, the EU treaty would hold nations accountable before the European Court of Justice if they failed to comply with deficit limits. And the treaty would be difficult to undo.

"If several rounds of negotiations are necessary for that then we are also prepared for that," the senior German official said, adding "there is still no majority on new treaty changes among the member states and institutions."

A senior French official, who spoke on condition of anonymity because talks were on going, said Paris remained optimistic that a tentative deal among the eurozone's members -- and others who want to join voluntarily -- could still be struck by Friday night. This official said it is looking less likely that an agreement would come from all EU leaders.

The 10 EU countries that do not use the euro are concerned about this. They fear being left out of future economic discussions that would affect all of Europe. Germany has insisted that any interested countries would be welcome to adopt the changes of the eurozone 17.

British leader David Cameron is wary of losing influence within Europe if France and Germany create a tighter club of eurozone nations. His government also does not want to transfer any of its decision-making powers to Brussels.

Earlier Wednesday, U.S. Treasury Secretary Timothy Geithner struck a more optimistic tone on the prospects for a deal.

"We are very encouraged with the progress that is being made," Geithner said to reporters following a meeting with French Finance Minister Francois Baroin on the second day of his whirlwind trip through Europe.

A successful resolution of the differences between the European leaders is crucial if the ECB is to step up its support for weak eurozone countries.

ECB President Mario Draghi hinted last week that a commitment by euro countries to crack down on overspending could set the stage for further financial assistance from the bank.

Markets have interpreted Draghi's comments to mean that the ECB could get more aggressive in purchasing European government bonds. Those bond purchases would likely drive down interest rates, allowing debt-laden countries to cut their borrowing costs.

The ECB will hold a policy meeting on Thursday, and investors will watch Draghi's comments in a news conference for signs he considers Merkel and Sarkozy's proposal enough to embark on greater support for eurozone bond markets.

The proposals floated by the German and French leaders are based on several key issues:

- Having all 17 countries that use the euro amend their constitutions to require balanced budgets.

- Using EU institutions such as the European Commission to enforce penalties for countries that run excessive budget deficits. The use of those institutions might require that all 27 EU countries agree to it.

- Trying to increase the EU's financial ability to bail out countries.

- Pledging that any future bailouts would not require private bond investors to absorb part of the costs, as was the case for the Greek bailout.

- Finally, the proposal seeks to streamline the eurozone's future (euro) 500 billion ($669 billion) permanent bailout fund by suggesting that a majority of countries holding 85 percent of the ECB's capital should be sufficient to make all decisions. That would give the bloc's six biggest economies the power to outvote the remaining 11 nations, a move that is likely to be opposed by smaller countries.

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Gabriele Steinhauser and Don Melvin in Brussels, David McHugh in Frankfurt, and Greg Keller and Sylvie Corbet in Paris contributed to this report.