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Merkel Outflanked in Crisis Summit as Hollande Backs Italy-Spain

French President Francois Hollande led a rebellion against Germany’s prescriptions for dealing with the debt crisis, rattling Europe’s political system with demands for immediate relief for hard-hit countries.

Hollande put French endorsement of a German-inspired deficit-control treaty on hold, and Italy and Spain withheld approval of a 120 billion-euro ($149 billion) growth-boosting package unless Germany authorizes steps to calm their bond markets.

By provoking an open breach with German Chancellor Angela Merkel, the new French leader overturned the austerity-first consensus that has dominated the debt-crisis response and risked fracturing the Berlin-Paris alliance that built the European Union and euro.

“We now need to have a stability policy in order to support the countries that took some efforts,” Hollande told reporters early today at a summit in Brussels, the 19th since the crisis erupted. “Stability measures should be a priority before any other consideration.”

As the top-level talks dragged on, a group of senior officials from national finance ministries grappled with whether to use the bond-buying powers of the bloc’s bailout funds to try to trim Italy’s 10-year yields from 6.20 percent and Spain’s from 6.94 percent.

Euro Chiefs

Leaders of the 10 EU countries outside the euro streamed out of the summit headquarters around 1 a.m., leaving the 17 euro chiefs to deliberate into the early hours. Hollande said German concessions would determine whether he assents to the deficit-reduction pact, which was endorsed by his predecessor Nicolas Sarkozy, by the time the summit ends later today.

“Two countries feel very strongly about reaching an agreement on long and short-term measures,” EU President Herman Van Rompuy said late yesterday. “The discussion isn’t blocked, but continues.”

With global powers from the U.S. to China calling for Europe to take decisive steps, the clash added to doubts whether the euro’s custodians can muster the will to use what Van Rompuy dubbed “better fire-brigade equipment” when the anti-crisis tools were strengthened last year.

“Incremental” policies no longer work, Canadian Finance Minister Jim Flaherty, the longest-serving Group of Seven finance chief, said yesterday in Galway, Ireland. European leaders must “quickly begin to implement the bold actions that they understand are needed.”

Italian Debt

Beset with the euro area’s second-highest debt load at 120.1 percent of gross domestic product, Italy yesterday paid the most since December to sell 10-year bonds. Italian yields have jumped 50 basis points since Spain requested bank aid on June 9 amid concern that Italy is next in line.

Spanish Premier Mariano Rajoy has appealed that aid be channeled directly to the troubled lenders, while Italian Prime Minister Mario Monti argues that Italy’s debt is a legacy of policy mistakes in the 1970s and 1980s. He says his government’s steps such as a labor-market reform passed this week will generate the growth and tax receipts to pay it down.

Monti, a non-partisan former European Commission official who was appointed prime minister last year, said Italy’s deficit cuts and surplus before interest costs make it worthy of a European backstop.

“If the public opinion sees that bad signals, not good signals are coming back from the markets, well then people might be discouraged and political forces which say let European integration, let the euro, let this or that country go to hell might prevail,” Monti said on the eve of the summit.

German Weight

As Europe’s dominant economy, Germany can control the use of the aid funds: the temporary European Financial Stability Facility, set up in 2010, and the European Stability Mechanism, a permanent fund to be phased in starting next month.

German lawmakers vote later today on both the ESM and the fiscal pact that set down new EU budget rules, leaving Merkel little room to maneuver.

While 500 billion euros in fresh money is available, the euro zone has already pledged as much as 100 billion euros to recapitalize Spain’s banks and another 10 billion euros for Cyprus. Those programs would bring to five the number of countries tapping European assistance.

Watching from the sidelines is the European Central Bank, which bought 219.5 billion euros of ailing countries’ bonds until suspending the purchases in February under pressure from German representatives on its policy council.

No Merkozy

France’s Hollande stood with the struggling countries on the periphery, breaking with the close coordination between France and Germany that marked the first two years of the crisis that was spawned in Greece in 2009 and gave rise to the team of “Merkozy” -- Sarkozy and Merkel.

“Monti and Rajoy had warned me about the positions they were planning to take,” Hollande said as chiefs from the euro bloc began meeting during, the second summit since his election in May and the first since legislative balloting gave his Socialist party a majority in France’s parliament. “They believed, and I understand them, that they could not give a partial agreement but a global accord.”

Hollande was a driving force behind the growth package, which includes a 10 billion-euro capital boost for the European Investment Bank, the EU’s project-financing arm. Some existing EU subsidies will be retargeted and EU guarantees will be used for private bond issues to finance transport and construction projects .

While the new French government strayed from the German line, Merkel wasn’t alone. She counted Finland and the Netherlands, two other countries that have retained top credit ratings, as allies amid taxpayer unease with further bailouts.

“It’s difficult to find any miracles because we have our rules and we have to stick to them,” Finnish Prime Minister Jyrki Katainen said.

To contact the reporters on this story: James G. Neuger in Brussels at jneuger@bloomberg.net; Helene Fouquet in Brussels at hfouquet1@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net

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