FRANKFURT (Reuters) - German Chancellor Angela Merkel bluntly rejected euro zone bonds on Thursday as a solution to the currency area's sovereign debt crisis, saying that "collectivizing debts" would not solve the problem.
The European Union's top economic official meanwhile said he expected international lenders to be able to recommend by the end of the month releasing a vital next tranche of aid for Greece, warding off the threat of an imminent default.
Spain and France both found good demand for their bonds at auctions, but while Paris' short-term borrowing costs fell, Madrid had to pay dearly to sell longer-term debt despite support from the European Central Bank in the secondary market.
Speaking a day after the head of the European Commission raised financial market hopes by pledging to present options soon for issuing such common bonds, Merkel said: "Eurobonds are absolutely wrong.
"In order to bring about common interest rates, you need similar competitiveness levels, similar budget situations. You don't get them by collectivizing debts," she said in a speech at the Frankfurt auto show.
The chancellor, facing rising public opposition to euro zone bailouts, said there was no quick and easy way out of the debt crisis, only a step-by-step process of individual countries putting their fiscal house in order.
Many investors see joint debt issuance as the best way out since it would reassure markets that Europe's strongest economies were taking responsibility for weaker states.
But Germany, the euro zone's main paymaster, argues that it would raise the borrowing costs of virtuous countries and remove the incentive for profligate states such as Greece or Italy to clean up their public finances.
European Central Bank policymaker Lorenzo Bini Smaghi highlighted that risk in a speech in Rome on Thursday.
"Without stringent constraints, eurobonds risk favoring fiscal policies that, on average, are more expansionary, and a higher debt, whose cost is also shared among the more disciplined countries," he said.
On a conference call with Greek Prime Minister George Papandreou on Wednesday, Merkel and French President Nicolas Sarkozy voiced their support for keeping Greece in the euro zone and continuing financial assistance provided it sticks strictly to austerity measures to meet its fiscal targets.
EU Economic and Monetary Affairs Commissioner Olli Rehn said he now expected an EU/ECB/IMF "troika" of inspectors to be able to complete their review of Greece's fiscal targets by the end of the month.
"Over the last weekend, the Greek government took very important decisions that go a long way to meeting the fiscal target for this year," Olli Rehn told a news briefing.
"It is now essential that they go all the way and convince their partners so that they can expect a decision to be taken by the euro area and the IMF in time before the next hurdles of financing will emerge," he said.
Separately, the Commission said economic growth in Europe was slowing down and could come close to a halt at the end of the year partly because the debt crisis will hit household consumption and investment.
"The outlook for the European economy has deteriorated. Recoveries from financial crises are often slow and bumpy," Rehn said, rejecting any return to stimulus spending.
There were some signs that political support in Germany for continuing aid to Greece was rallying after weekend comments about the possibility of a Greek default and exit from the euro area spooked markets.
Michael Meister, deputy parliamentary leader of Berlin's governing conservatives, said Athens was doing its utmost to deliver on its fiscal targets and it would be "absolutely fatal" for Greece to leave the euro zone.
He also voiced confidence that parliament would ratify an increased role for the euro zone's EFSF rescue fund on September 29 after votes in the Austrian and Slovak parliaments were delayed by internal opposition.
German Vice-Chancellor Philipp Roesler also softened earlier comments, stressing he did not favor Greece leaving the euro zone and his party's position was close to Merkel's.
(Writing by Paul Taylor; editing by Janet McBride)
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