PARIS/BERLIN (Reuters) - French President Nicholas Sarkozy has embraced a German campaign for treaty change that could give European authorities intrusive powers to intervene in the national budgets of countries sharing the euro currency.
France and Germany will soon propose amendments to the European Union treaty in response to the bloc's sovereign debt crisis, Sarkozy said on Tuesday.
"With (Chancellor Angela) Merkel, we will soon make proposals on modifying the treaties to prevent countries from diverging in the budgetary, economic and fiscal areas," he told an Asian forum in Paris.
"We will do everything not just to defend Europe but also to consolidate it."
Treaty change in the EU is a fraught process. France has long defended its own national fiscal and economic sovereignty and its voters rejected a proposed EU constitution in a 2005 referendum.
But diplomats said Sarkozy has little alternative to going along with Merkel because France's top-notch AAA credit rating is under threat and the risk premium investors demand to hold French debt rather than German bonds is rising.
After a day when the borrowing costs of most of the weaker euro zone economies continued to rise inexorably, the President of the European Council, Herman Van Rompuy, called for "crisis measures" -- an apparent hint to the European Central Bank to take further action.
Sarkozy praised the ECB's role in buying limited amounts of euro zone bonds to calm markets but refrained from calling for more decisive intervention, in contrast to his finance minister.
EU paymaster Germany continues to block the two most widely-touted exit routes from a crisis that is shaking the world economy -- massive ECB intervention to buy government bonds, or joint issuance of euro zone debt.
Influential ECB policymaker Jens Weidmann, head of Germany's Bundesbank, spelled out his rejection of the former in a speech to employers in Berlin.
"(The ECB) would overstretch its mandate and call into question the legitimacy of its independence by accepting a role of lender of last resort for highly indebted member states," Weidmann said.
Anyone who believed the crisis could be overcome by giving up stability-oriented principles, and by pushing aside existing legislation, was wrong, he said. "To do that would be like drinking sea water to kill thirst."
Merkel called for much tougher rules to override national budget sovereignty if euro zone states fail to follow EU rules.
It was "not very appropriate" to discuss jointly issued euro zone bonds now, since mutual debt guarantees could come only at the end of a European integration process, if at all, she said.
Spain's short-term borrowing costs hit a 14-year high on Tuesday despite the landslide election victory on Sunday of a conservative party committed to budget cuts.
Prime Minister-elect Mariano Rajoy disappointed investors by refusing to give any clearer indication of his austerity plans or his choice of economy minister until he is sworn in on December 20, leaving the kind of policy vacuum that markets abhor.
Credit ratings agency Fitch said Spain's new government had a brief chance with its fresh mandate to make the extra savings needed to meet its existing fiscal targets.
"If it is to improve market expectations of its capacity to grow and reduce debt within the confines of the euro zone, it must positively surprise investors with an ambitious and radical fiscal and structural reform program," Fitch said.
The ECB's limited, stop-go purchases of Spanish and Italian government bonds have failed to provide durable relief.
"If it wasn't for the ECB, there wouldn't be a Spanish or Italian bond market," said Gary Jenkins, head of fixed income at Evolution Securities.
New Italian Prime Minister Mario Monti outlined his reform plans in Brussels as Italy's two-year bond yields rose back above 10-year yields in a sign of market stress, prompting the ECB to buy short and medium-term Italian paper, dealers said.
European Commission President Jose Manuel Barroso said Monti's reform program correctly addressed the enormous challenges facing Italy, which must pursue its efforts to regain investors' confidence. There was no mention of financial support for Rome, whose borrowing costs have touched levels at which Greece, Ireland and Portugal sought bailouts.
In an indicator of how sovereign debt problems have virtually frozen inter-bank lending markets, euro zone banks' demand for ECB funds surged to a two-year high.
The ECB's weekly, limit-free handout of funding underscored the widespread problems with 178 banks requesting a total of 247 billion euros ($333 billion), the highest amount since the peak of the global financial crisis in mid-2009.
Investors in Europe and beyond have been selling euro zone government bonds as the two-year-old debt crisis has tainted even core countries such as France, Austria and the Netherlands.
Belgian bond yields spiked on Tuesday after the man widely seen as most likely to form a government and end an 18-month political crisis submitted his resignation to King Albert due to a deadlock over the 2012 budget.
With a sovereign debt burden nearly as big as its annual economic output, Belgium's borrowing cost jumped to 5.1 percent for 10-year bonds after Socialist Elio Di Rupo pulled out.
Germany's Merkel has insisted the only answer to the bond markets rout is for states to embrace austerity measures and structural reforms to make their economies more competitive.
She has also pressed for the euro zone's rescue fund to speed up plans for scaling up its firepower to provide bond insurance and credit enhancements for foreign investors.
Euro zone finance ministers are due to approve detailed proposals next Monday, but analysts have voiced strong doubts about the prospects of achieving the 1 trillion euros in leverage targeted by EU leaders at a summit last month.
Echoing Merkel's call for stricter fiscal discipline, Economic and Monetary Affairs Commissioner Olli Rehn said the EU executive would seek more intrusive powers to make sure national budgets in the euro zone do not break agreed rules.
The Commission will call for balanced budget rules to be inscribed into national law, preferably the constitution. It will also propose that budget planning be done on the basis of forecasts by national fiscal councils independent of government.
Rehn said a proposal from the German government's panel of independent economic advisers for a euro zone debt redemption fund that would mutualise the bloc's debt stock on stringent conditions was worth further study.
Merkel has questioned the legality of the idea and said it would be "impossible to implement in reality."
In Greece, where the crisis began, a standoff continued over the main conservative party leader's refusal to sign a written commitment to austerity measures.
Dutch Finance Minister Jan Kees de Jager said euro zone finance ministers would not approve the release of a desperately needed 8 billion euro aid installment next week unless Antonis Samaras of New Democracy gave a written pledge.
"Saying that words are enough -- we've passed that stage. We want a signature from this Mr Samaras," De Jager told RTL7 tv.
Greek private sector workers announced plans for a one-day strike against welfare cuts on December 1, the first since technocrat Prime Minister Lucas Papademos took office at the head of a national unity government.
($1 = 0.7410 euros)
Additional reporting by Paul Day in Madrid, Emelia Sithole-Matarise and Ana Nicolaci da Costa in London, Paul Carrel in Frankfurt, Robert-Jan Bartunek in Brussels, Gilbert Kreijger in Amsterdam, Harry Papachristou in Athens; Writing by Paul Taylor; editing by Janet McBride/David Stamp/Ruth Pitchford