European Union leaders wrestled on Thursday (1 March) with the balance between budget austerity and reviving lost growth at the first summit for two years in which the eurozone debt crisis did not eclipse all else.
After their finance ministers gave provisional approval to a second bailout for Greece, and a flood of cheap European Central Bank funds calmed bond markets, the 27 leaders used the breathing space to focus on structural economic reforms and other ways to combat record unemployment.
"The crisis is not over, but this meeting is not a crisis meeting," Finnish Prime Minister Jyrki Katainen said.
Leaders of 25 of the 27 countries will sign a German-driven fiscal compact treaty on Friday to enforce EU deficit-cutting and debt reduction rules more strictly.
But without a return to growth several European countries risk entering the same spiral of depression as Greece.
"Europe doesn't just face a debt crisis. Europe also faces a growth crisis," British Prime Minister David Cameron told reporters, calling for more market deregulation to unleash economic dynamism.
German Chancellor Angela Merkel said the ECB's massive cash injection to banks had bought Europe's politicians precious time to work on improving competitiveness, growth and employment.
"We absolutely must make use of this time, otherwise we will find that the world does not trust us," she said.
Unemployment in the 17-nation eurozone hit a euro-era record 10.7% in January, data out on Thursday showed, and the eurozone's manufacturing sector contracted for the seventh month running in February.
While jobless totals in economic powerhouse Germany continue to decline, the unemployment rate in Spain rose to 23.3%, with one young person in two out of work. Italy is little better off.
"Despite the euphoria in the banking sector following the ECB's loan programme, the real economy remains very depressed and the key factor is the unemployment rate, both socially and because of the damage to growth," said Steen Jakobsen, an economist at Saxobank.
Spanish test case
Spain is emerging as a test case of whether Europe is willing to ease its drive for balanced budgets to allow more scope for the growth that is essential to pay down public debt.
Madrid reported this week its 2011 deficit hit 8.5% of gross domestic product, far above the 6% target agreed with Brussels. That means it would have to cut the equivalent of four percentage points of GDP to meet this year's target of 4.4%, while the economy is forecast to contract by 1%.
Prime Minister Mariano Rajoy's new government is privately pleading for more realistic revised targets, posing a dilemma for the European Commission, which is trying to restore the credibility of rules flouted in the past not only by Greece but also by Germany and France, the bloc's two biggest economies.
"Spain is going to meet all its commitments in terms of budget adjustments taking into account the fact that the situation has changed," Economy Minister Luis de Guindos said.
"The previous government had agreed to reduce the deficit to 4.4% based on growth of 2.3%, which is not the case today," he told reporters.
Finland's Katainen, a deficit hawk, said it would be "completely wrong" to give countries more room to meet their fiscal targets.
De Guindos said he did not expect an EU decision until May, but a government source in Madrid said the government would set a 2012 spending limit on Friday based on a deficit target of around 5.3 to 5.5%, defying the Commission.
Decision postponed on boosting EU firewall
At Merkel's insistence, the issue of increasing the size of the currency bloc's rescue fund was not on the agenda, but her partners will be looking for assurances that Berlin is ready to budge on the issue later this month.
Merkel faces strong public hostility to further bailouts and a backbench revolt in her centre-right coalition that could make it hard to win parliamentary support for a bigger bailout fund.
German officials say that with bond market tensions easing, there is no immediate need to combine the existing temporary rescue fund with a planned permanent €500-billion European Stability Mechanism to build a bigger firewall.
Major economies in the Group of 20 told the Europeans last weekend they would not give the International Monetary Fund more money to combat the fallout from the eurozone crisis unless Europe first increased its own warchest.
The lending ceiling of the EU's two bailout funds – the European Financial Stability Facility (EFSF) and its successor as of July, the European Stability Mechanism (ESM) – "will be reassessed by the end of March," the leaders said in a statement.
ECB cash injection buys some time
A day after the ECB pumped €530 billion of cheap, three-year liquidity into European banks, yields on Italian 10-year bonds fell below 5% for the first time since last August. Spanish yields also dropped and safe-haven German Bund futures slid in a sign of investors' returning risk appetite.
The industry body which determines when bondholders are entitled to cash in credit insurance said recent preparations for a debt restructuring do not so far constitute a "credit event" triggering a credit default swaps payout.
Economists say the ECB's massive money creation buys time for the eurozone but will not solve the bloc's problems, which require a return to competitiveness and growth in peripheral member states and a rebalancing between the strong and weak.
Fiscal compact treaty faces hurdles
Meanwhile, the fiscal compact treaty which Merkel demanded as a condition for further financial assistance to countries in trouble faces two hurdles.
Ireland announced this week it would put the matter to a referendum in a country suffering from a steep economic decline and under an EU/IMF bailout programme.
Perhaps the bigger uncertainty lies in France, where opposition Socialist presidential candidate François Hollande has vowed to renegotiate the treaty to add measures to promote growth if, as opinion polls suggest, he defeats conservative President Nicolas Sarkozy in a May runoff.
European Council President Herman Van Rompuy, in a paper prepared for the summit, said those countries under market scrutiny must pursue fiscal consolidation in earnest, but others should use their budgetary room for manoeuvre to boost demand to fight economic stagnation.