European Union leaders are unlikely to take a decision on how to strengthen the euro zone's bailout fund until June, undermining market confidence and possibly prolonging the region's debt crisis.

For months, EU leaders have talked about using a summit in Brussels this Thursday and Friday to reach a final agreement on a comprehensive package of measures that they hope will prevent the debt crisis from spreading further.

Although the leaders have decided to raise the effective lending capacity of the European Financial Stability Facility from 250 billion euros to its full size of 440 billion euros, they have not yet been able to agree on how to do that.

Draft conclusions prepared for this week's summit, seen by Reuters on Wednesday, make clear that a definitive decision on how to bolster the fund will only be taken when leaders also formalize the structure of the European Stability Mechanism, a permanent fund that will replace the EFSF in 2013.

The preparation of the ESM treaty and the amendments of the EFSF agreement, to ensure its 440 billion euro effective lending capacity, will be finalized so as to allow national procedures to be completed in good time for signature of both agreements at the same time before the end of June 2011, the documents say.

News of the delay, coupled with concern that Portugal may soon follow Greece and Ireland in requiring emergency aid from the EU, drove down the euro and pushed up government bond yields for weaker euro zone states on Wednesday.

On Wednesday night, Portuguese Prime Minister Jose Socrates submitted his resignation to the president after parliament rejected new austerity steps that he had hoped would convince markets Lisbon was getting to grips with its budget deficit.

Socrates had said previously that a rejection of the steps would probably force Portugal to seek foreign aid. His government will for now keep power in a caretaker capacity.

If these measures are not agreed, it seems more and more likely that Portugal will need some kind of support, said Charles Diebel, head of market strategy at Lloyds Bank.

Is this already reflected in the price? To a large degree yes it is, but there are also good causes for concern that this is not going to stop here.

A euro zone source estimated in January that were Portugal to ask for aid, it might need between 60 and 80 billion euros. Those amounts would be comfortably within the scope of the EFSF even before its planned expansion, but it might be difficult for a caretaker government in Lisbon to negotiate bailout terms.

INCONCLUSIVE SUMMIT

The EU's delay in reaching a deal to bolster the EFSF is partly due to politics and partly the result of a need to coordinate the legal and structural changes that being introduced and avoid national parliaments rejecting them.

Finland has dissolved its parliament ahead of an election on April 17 and cannot take any formal decisions until it has a new government in place, something that is only likely by May at the earliest.

There are also doubts in Germany about what capital commitments it needs to make to finance the ESM, which will have an effective capacity of 500 billion euros.

EU finance ministers agreed on Monday that the ESM would have paid-in capital of 80 billion euros and 620 billion euros of either callable capital or guarantees, a total that would ensure a triple-A credit rating.

While this is essentially a technical issue, it contributes to a sense in financial markets that EU member states are endlessly at odds over how best to handle the debt crisis, and that everything could unravel if deals are not respected.

NO MOVE ON IRELAND

Further undermining confidence is the expectation that no progress will be made at the summit on reducing the interest rate on bailout loans already made to Ireland. Dublin says the rates are cripplingly high and wants them lowered.

But agreement has been held up by Dublin's refusal to give in to German and French pressure for Ireland to raise its corporate tax rate.

There is almost certainly not going to be a resolution of the Irish issues tomorrow or Friday, said an EU diplomat.

The feeling is that the outstanding issues for Ireland, which are not just the interest rate but the banking question, that they are better dealt with as a package, he added, referring to upcoming tests of the health of Irish banks.

Regardless of whether euro zone governments can agree on their crisis package in coming weeks, further pain for some investors in the weak economies may be inevitable.

It is only a matter of time before Greece, which is receiving a 110 billion euro bailout from the EU and the International Monetary Fund, has to restructure some of its sovereign debt, a former chief economist of the European Central Bank said.

As soon as the other countries are out of danger, the Greek government debt will have to be restructured, Otmar Issing told Germany's Der Spiegel magazine. This can be done by cutting that debt or by extending the terms of the loans, but there is no getting around a debt restructuring.

(Reporting by Julien Toyer, Jan Strupczewski, John O'Donnell, and Luke Baker and by Paul Carrel in Frankfurt and Stephen Brown in Berlin; Editing by Andrew Torchia)

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