Germany and France stepped up a drive on Monday for intrusive powers to reject national budgets in the euro zone that breach EU rules, as a market rout of European debt eased temporarily on hopes of outside help for Italy and Spain.
The OECD rich nations' economic think-tank said the European Central Bank should cut interest rates and step up its purchases of government bonds to restore confidence in the euro zone, which it said now posed the main risk to the world economy.
In Brussels, finance ministers of the 17-nation currency area meeting on Tuesday are due to approve detailed arrangements for scaling up the European Financial Stability Facility rescue fund to help prevent contagion spreading in bond markets, and to release a vital aid lifeline for Greece.
Berlin and Paris aim to outline proposals for a fiscal union before a European Union summit on December 9 increasingly seen by investors as possibly the last chance to avert a breakdown of the single currency area.
"We are working intensively for the creation of a Stability Union," the German Finance Ministry said in a statement. "That is what we want to secure through treaty changes, in which we propose that the budgets of member states must observe debt limits."
It also dismissed a report by the newspaper Die Welt that Germany and the five other euro zone states with top-notch AAA credit ratings could issue joint bonds.
Finance Minister Wolfgang Schaeuble acknowledged on Sunday that it may not be possible to get all 27 EU member states to back treaty amendments, saying agreement should be reached among the 17 euro zone members.
"That can be done very quickly," he told ARD television, adding that it only required changing an additional protocol to the EU's Lisbon Treaty.
"END OF THE EURO?"
In France, Agriculture Minister Bruno Le Maire said euro zone countries would have to give up some budget sovereignty to save the euro from hostile "speculators."
"We won't be able to save the euro if we don't accept that national budgets will have to be a bit more controlled than in the past," Le Maire told Europe 1 radio.
"We are in an economic war with a number of powerful speculators who have decided that the end of the euro is in their interest," he said.
Handing over fiscal sovereignty to the executive European Commission is politically sensitive in France, which has a strong Gaullist, nationalist tradition.
President Nicolas Sarkozy's office sought to quash a weekend newspaper report that Berlin and Paris were planning to confer "supranational powers" on Brussels, suggesting such intrusion would only apply to countries such as Greece that were under EU/IMF bailout programs.
But Le Maire, asked whether the Commission would be granted more powers over national budgets in the euro zone, said: "Why not? The French people have to realize what is at stake -- the preservation of our common currency and our sovereignty.
"We'll see if it's the council (of ministers) or some other European institution (that exercises these powers). What matters is that we ensure that budget discipline is respected within the euro zone. Otherwise the euro itself is threatened."
He acknowledged that France and Germany were still at odds over greater ECB intervention to rescue the euro but said: "We will have to find a compromise."
On financial markets, the euro regained ground after slipping below $1.33 in Asia. Italian, Spanish, French and Belgian bond yields fell, as did the cost of insuring those countries' debt against default.
But relief may be short-lived as the rally was partly due to an Italian newspaper report that the International Monetary Fund was in talks to lend Italy up to 600 billion euros -- more than its entire available war chest -- which the IMF denied.
"There are no discussions with the Italian authorities on a program for IMF financing," a spokesperson for the global lender said.
The European Commission also said Italy had not asked for any amount of money and there were no discussions at European level on aid for Rome.
IMF inspectors are due in Rome this week to study Italy's public finances after former Prime Minister Silvio Berlusconi agreed earlier this month to submit to regular monitoring of his promised austerity measures and economic reforms.
IMF TO THE RESCUE?
EU officials say some sort of IMF program could make sense for both Italy and Spain as part of a multi-pronged response involving the ECB and the euro zone rescue fund to implement reforms and restore market confidence in their debt.
A senior EU source confirmed that both Berlusconi and the European authorities had rejected an IMF offer of a 50 billion euro precautionary credit line for Italy in talks on the sidelines of the Cannes G20 summit on Nov 3. The source said the sum would have been insufficient to convince markets.
Reuters reported exclusively last week that Spain's People's party, due to form a new government by mid-December, is considering applying for IMF aid as one option for shoring up public finances. [ID:nL5E7MP2R0]
In its world economic outlook, the Organization for Economic Cooperation and Development forecast growth in the euro area will slow -- under a baseline scenario of "muddling through" -- to 0.2 percent in 2012 from an estimated 1.6 percent in 2011. The bloc's economy will then expand by 1.4 percent in 2013.
With unemployment set to rise and inflation to fall, the OECD said the choice for the ECB was clear.
"This calls for ... a substantial relaxation of monetary conditions," the OECD said.
Banks would need to be well capitalized and policies put in place for sovereigns to finance themselves at reasonable rates.
"This calls for rapid, credible and substantial increases in the capacity of the EFSF together with, or including, greater use of the ECB balance sheet," the OECD said.
OECD chief economist Pier Carlo Padoan said current plans to leverage the euro zone bailout fund were insufficient.
"The numbers we have seen floating around are not enough," Padoan told a news conference, adding that what was needed was a multiple of what was currently on the table.
Euro zone leaders initially planned to leverage the EFSF up to 1 trillion euros, but the fund's head has said it is now unlikely to achieve that. The fund has had trouble selling its own bonds to raise funds and has yet to attract the pledges it hoped to get from countries with sovereign wealth to invest.
(Additional reporting by Leigh Thomas in Paris and Emelia Sithole-Matarise in London; writing by Paul Taylor; editing by Philippa Fletcher)Copyright 2011 Thomson Reuters. Click for Restrictions.