June 19 (Bloomberg) -- European Union leaders spotted the first signs of a “sustainable economic recovery” from the worst recession since World War II and started planning to roll back budget deficits piled up to combat the financial crisis.

The 27 government heads today said the looming end of the slump means it is time to start hatching an “exit strategy.” They also agreed to overhaul financial regulation after banking supervision failed to contain the crisis sparked in the U.S. housing market.

“It is important that consolidation keeps pace with economic recovery,” the leaders said in a statement after a two-day summit in Brussels. “There is a clear need for a reliable and credible exit strategy.”

The EU leaders’ outlook is more upbeat than that struck last week at a meeting of Group of Eight finance ministers, which ended with a statement noting “signs of stabilization in our economies.” U.S. Treasury Secretary Timothy Geithner said at those talks that “it’s too early to shift toward policy restraint.”

The expression of official optimism pushed the euro higher and prompted declines in European government bonds. The currency was up 0.1 percent at $1.3909 at 4:15 p.m. in Brussels.

Extra spending by European governments will pump 5 percent of gross domestic product into the 27-nation economy in 2009 and 2010, helping restore growth after this year’s estimated 4 percent contraction, according to EU forecasts. “The significant measures taken by governments and central banks are contributing to limiting the negative effects of the downturn and helping to safeguard jobs,” according to the statement.

Credit Crisis

The leaders agreed to their most sweeping overhaul of financial regulation, sharpening scrutiny of banks and risks after spending billions propping up lenders in the credit crisis. They backed the creation of agencies to unify oversight of banks, insurers, investment firms, credit-rating companies and hazards in the broader economy.

The accord gives the EU its most centralized power over financial firms even after U.K. Prime Minister Gordon Brown won a compromise to scale back some of the authorities’ power to override national decisions involving public money. The region’s governments and central banks are on the hook for more than 3.7 trillion euros ($5.2 trillion) of guarantees and funding.

Concerned that Britain’s economy might need another shot in the arm, Brown objected to a draft text that said “further budgetary stimulus would not be warranted” and got the phrase expunged from the final communiqué.

Budget Deficits

German Chancellor Angela Merkel has pushed for governments to start cutting budget deficits, which will rise to an average of 6 percent of GDP in 2009 from 2.3 percent last year, the EU forecasts. Economic data released this month suggest the region is starting to pull out of the slump.

In Germany, Europe’s largest economy, investor sentiment rose more than economists forecast to a three-year high this month, the ZEW Center for European Economic Research in Mannheim said this week. Euro-area business and consumer confidence increased to the highest in six months in May, and the service and manufacturing industries contracted at a weaker pace.

The International Monetary Fund, the Washington-based lender with 185 member nations, raised its forecast for global economic growth in 2010 to 2.4 percent from 1.9 percent, a person familiar with the matter said on June 11. John Lipsky, the IMF’s first deputy managing director, said today that the fund expects to revise its growth forecasts “modestly upward” to reflect signs that the global slowdown is moderating.

Economic Growth

Underscoring investor expectations of a revival in economic growth, Europe’s Dow Jones Stoxx 600 Index gained 0.9 percent to 207.55. The MSCI World Index of developed-nation stocks has added 40 percent since March 9 and crude-oil futures have jumped 61 percent this year.

Taylor Wimpey Plc, the U.K.’s largest homebuilder, said today that its British order book surged 73 percent from the end of last year as buyers returned to the housing market and prices stabilized. Praktiker AG, Germany’s second-biggest home- improvement retailer, said on May 27 that revenue has rebounded in its domestic market since the end of March.

Still, other data suggest the recovery is fragile and uneven. Retail sales in the U.K., Europe’s second-biggest economy, unexpectedly dropped in May for the first time in three months, the Office for National Statistics said today.

Coming economic “data will most likely be mixed, confirming that activity is stabilizing at a very low level,” said Marco Annunziata, chief economist at Unicredit MIB in London. The reports are “unlikely to give unequivocal support to the idea of a strong V-shaped recovery, especially given the residual fragility of the financial sector.”

To contact the reporters on this story: Jonathan Stearns in Brussels at jstearns2@bloomberg.net; James G. Neuger in Brussels at jneuger@bloomberg.net.

Last Updated: June 19, 2009 10:16 EDT