Euro Drops As Leaders Meet; France, Germany Split

As European leaders struggled to hold the euro zone together at a nighttime summit in Brussels, a widening gap emerged between Germany and France, which are now under new management.

As they met, the euro fell to $1.2555 from $1.2600, and the Yen to Y99.73 from Y100.16, Dow Jones Newswires reported.

Overnight, the common currency dropped to its lowest level against the dollar since July 2010, amid growing doubts that Greece would be able to remain in the euro zone.

Early Thursday, EU President Herman Van Rompuy emerged from the meeting after more than five hours of negotiations with no concrete measures to speak of for tackling Europe's economic crisis, but he said that the discussions had been focused and frank, the Los Angeles Times reported.

Tonight's meeting was about [increasing] pressure, focusing minds and clearing the air, Van Rompuy said. He added that tangible measures would be hashed out at a formal EU summit late next month.

Van Rompuy stressed that the EU would look at balancing the need for growth with the need for fiscal retrenchment.

Pitting one against the other is a false debate, he said. They are two sides of the same coin.

While France, led by new President Francois Hollande, is pushing for increased sharing of EU debt and growth through stimulus measures, German Chancellor Angela Merkel is holding fast to her prescription of tough public-spending cuts and an every-nation-for-itself philosophy when it comes to borrowing money.

The split, sparked by Hollande's election on May 6, is in marked contrast to the relatively united front Merkel forged with the French leader's ousted predecessor, Nicolas Sarkozy.

On Wednesday night, the leaders put off making any decisions about shoring up banks despite rising concerns about the effect of the Greek debt crisis on the euro zone's financial sector.

The heads of the EU's main institutions were asked to draft proposals for closer fiscal co-ordination before the summit next month, including plans that could lead to a Europe-wide deposit guarantee scheme and, in the long term, commonly-backed euro zone bonds, the Financial Times reported.

Van Rompuy cautioned that the June plan would be limited to building blocks and working methods to foster economic integration and not geared toward offering specific proposals leading to a banking union or the mutualization of euro zone debt.

Advised by senior officials to prepare contingency plans in case Greece decides to quit the single currency, the leaders urged the country to stay the course on austerity and complete the reforms demanded by its bailout package, Reuters reported.

After nearly six hours of talks were held during an informal dinner Wednesday, leaders said they were committed to Greece remaining in the euro zone, but they insisted that Greece should to adhere to its side of the bargain, too, even at bitter cost.

We want Greece to stay in the euro, but we insist that Greece sticks to commitments that it has agreed to, Merkel told reporters after the summit dragged long into the night.

Hollande vowed Wednesday to push for the introduction of eurobonds, or debt collectively backed by all 17 nations that share the euro currency.

The idea of eurobonds has increasingly become a totem for countries such as France, Italy and Spain -- the euro zone's second-, third- and fourth-largest economies, respectively -- which see them as a way to calm investors and tamp down the financial crisis.

But Germany, the Netherlands and other more fiscally rigorous countries reject the idea because they would almost certainly be forced to pay higher rates to borrow money through the collective bonds than they do now as individual nations.

We see nothing in eurobonds, said Dutch Prime Minister Mark Rutte, who resigned in April but remained in a caretaker role. It doesn't foster growth, it will raise our interest rates and it is not the solution to the problem.

Even if opposing countries were to relent, setting up eurobonds would probably take months, which may not be timely enough aid to hold the euro zone currency union together.

Three officials told Reuters that instructions to have plans in place for a Greek exit were agreed upon Monday during a Euro Working Group (EWG) teleconference comprised of experts who work for euro zone finance ministers.

The Greek Finance Ministry denied there was any such agreement, but Belgian Finance Minister Steven Vanackere said, All the contingency plans [for Greece] come back to the same thing: to be responsible as a government is to foresee even what you hope to avoid.

Two other senior EU officials confirmed the call and its contents, saying that contingency planning was only sensible.

In its monthly report, Germany's Bundesbank said the situation in Greece was extremely worrying and that the country was jeopardizing any further financial aid by threatening not to implement reforms agreed to as part of its two bailouts.

It said a euro exit would pose considerable but manageable challenges for its European partners, raising pressure on Athens to stick with its painful economic reforms.

Greek officials have said that without outside funds, the country will run out of money within two months; in addition, the threat remains that if the nation crashes and falls out of the euro zone, other member states could be brought down, too.

Reuters reported on a document it viewed that detailed the potential costs of a Greek exit to individual member states, and which noted that if such an exit occurred, an amiable divorce should be sought, with the EU and IMF possibly giving up to 50 billion euros to clear its path.

Although EU leaders' minds have been focused by that prospect, disagreements have flared over a plan for mutual euro zone bond issuance and other measures to alleviate two years of debt turmoil, such as giving countries like Spain an extra year to make the spending cuts demanded of them.

The idea is to put energy into the growth motor, Hollande told reporters. All the member countries don't necessarily share my ideas. But a certain number expressed themselves in the same direction.

For the first time in more than two years of crisis summits, the leaders of France and Germany did not huddle beforehand to agree on positions, marking a significant shift in the axis that has traditionally driven European policymaking.

Instead, Hollande met Spanish Prime Minister Mariano Rajoy in Paris to discuss policy, before the pair travelled to Brussels by train.

Despite fears that Greeks could open the departure door if they vote for anti-bailout parties at a June 17 election, Spain, where the economy is in recession and the banking system is in need of restructuring, is also on the front line of the crisis.

After meeting Hollande, Rajoy said he had no intention of seeking outside aid for Spain's banks, which are laden with bad debts from a property boom that went bust and still has some way to go before it hits bottom.

But his government said its rescue of problem lender Bankia would cost at least 9 billion euros, and it is also seeking ways to help its highly indebted regions meet huge refinancing bills.

SHIFTING SANDS

Socialist Hollande's election victory has significantly changed the terms of the debate in Europe with his call for greater emphasis on growth, rather than debt-cutting now, as a rallying cry for other leaders.

That has set up a showdown with the conservative Merkel, whose primary objective is budget austerity and structural reform.

At his first EU summit, Hollande chose to make a stand on euro bonds -- issuing common euro zone debt -- despite consistent German opposition to the idea. I was not alone in defending euro bonds, he said.

Merkel showed no sign of dropping her objections to the proposal, which she has said can only be discussed after there is much closer fiscal union in Europe than there is presently.

There were differences in the exchange about euro bonds, she said bluntly.

The Netherlands, Finland and some smaller euro zone member states support her.

No major decisions were made at Wednesday's summit, which was intended to promote ideas on jobs and growth ahead of another meeting at the end of June.

But debate was intense, not just over euro bonds but over how to rescue banks and whether to give more time to struggling euro zone countries to meet their budget deficit goals.

We haven't come together to confront each other ... but we have to say what we think -- what are the right instruments, the right methods, the right steps, the right initiatives to raise growth? Hollande said.

The leaders discussed broad measures to stem the fallout from a winding up or restructuring of bad banks, EU officials said, with the European Central Bank pressing for the bloc to stand behind its struggling lenders but with Merkel's approval seen as far from guaranteed.

At the heart of the discussion are proposals from the European Commission for a legal framework to wind up or reorganize insolvent banks so as to avoid a repeat of the multi-trillion-euro taxpayer bailouts during the financial crisis.

Another suggestion is for the euro zone's rescue funds to be allowed to recapitalise banks directly, rather than having to lend to countries for on-lending to the banks. But that is another idea with which Germany is uncomfortable.

Having rallied on Tuesday, European stocks dropped 2.2 percent as investors priced in a lack of dramatic policy action. The euro tumbled against the dollar to its lowest since August 2010 and Spanish and Italian borrowing costs climbed.

A German two-year debt auction gave a stark illustration of how money is dashing for safe havens. Investors snapped up the 4.5 billion euros of paper on offer even though it came with a zero coupon -- offering no return at all.

SEARCH FOR GROWTH

With the euro zone registering no growth in the first quarter and threatening to slip back into recession, policymakers touted three ideas to provide stimulus:

* 'Project bonds' backed by the EU budget to finance infrastructure projects alongside private sector investment.

* Doubling the paid-in capital of the European Investment Bank, the EU's co-financing arm, to a little over 20 billion euros.

* Redirecting structural funds, which tend to flow to poorer countries, to other areas where they might reap more immediate growth rewards.

Even if all three proposals were to be activated quickly, economists say they will not provide a sufficient shot in the arm to the euro zone and the wider EU economy.

(Additional reporting by Jan Strupczewski, John O'Donnell, Catherine Bremer and Marine Hass in Brussels and Julien Toyer in Madrid. Writing by Mike Peacock, editing by Anna Willard and Giles Elgood)