Spain joins euro austerity drive

Spain belatedly joined the euro zone's austerity bandwagon Wednesday in response to a widening debt crisis as the European Commission sought an unprecedented right of prior review of national budgets.

Prime Minister Jose Luis Rodriguez Zapatero said Madrid would slash civil service pay by 5 percent this year, freeze it in 2011, cut investment spending and pensions and axe 13,000 public sector jobs in a drive to meet EU deficit targets.

We have to make a singular, exceptional and extraordinary effort to reduce our public deficit and we have to do it when the economy is starting to recover, he told parliament.

The announcement came two days after euro zone governments, the European Central Bank and the IMF agreed on a $1 trillion rescue package to stabilize the euro in exchange for pledges by highly indebted countries to pare down their deficits.

Portugal's finance minister said his government had picked a set of new measures for deeper spending cuts and would discuss them with the opposition before announcing them.

Portuguese Prime Minister Jose Socrates will meet the leader of the main opposition party Thursday to discuss the additional austerity measures, which the cabinet may approve in a weekly meeting later the same day.

U.S. President Barack Obama, who has intervened in the euro zone crisis because of risks to U.S. banks and economic growth, telephoned Zapatero Tuesday to press for resolute action to reform the Spanish economy, the White House said.

Spain enjoyed more than a decade of rapid growth fueled by EU aid and low euro interest rates, and long boasted a healthy budget balance and low debt. But public finances were severely hit by the collapse of a construction bubble in the 2007-8 credit crisis. The economy has lost competitiveness and unemployment stands at 20 percent.

After months in denial about the need for tougher measures, Zapatero announced an estimated 15 billion euros ($19.05 billion) in additional savings this year and next, sparking anger from trade unions usually on good terms with his Socialist party.

European shares rose despite figures showing the euro zone economy got off to a weak start in 2010 that will make deficit-trimming harder, with paltry first quarter growth in Germany and France.

GREEN LIGHT FOR ESTONIA

The euro was slightly up against the dollar but gold prices soared to a record high as investors sought a safe haven from government debt. The Austrian Mint said it had sold more gold in the last two weeks than in the entire first quarter.

Demand is exclusively from Europe, the mint's marketing director, Kerry Tattersall, told Reuters. That's a clear sign that there is panic buying because of concerns about Greece and the euro.

In a reminder that some east European countries are still keen to join the 16-nation single currency, Estonia won a green light from the Commission to join the euro area in 2011.

EU finance ministers are expected to ratify the decision in June. But the Baltic state is likely to be the last country to join for at least four years because other candidate countries have seen their deficits rise beyond the EU limit in the crisis.

Spanish and Portuguese borrowing costs soared last week as investors fled peripheral euro zone government bonds amid jitters over Greece's acute debt crisis spreading to other highly indebted EU countries.

But Portugal and Germany staged successful bond auctions on Wednesday after European Central Bank purchases of euro zone government debt in the market steadied investor nerves. The risk premium on Greek debt hit a three-week low.

In a drive to tighten fiscal discipline and prevent a re-run of Greece's fraudulent statistics and ballooning deficit, EU Economic and Monetary Affairs Commissioner Olli Rehn unveiled proposals for greater budget coordination Wednesday.

The key plank would make governments submit their draft budgets to Brussels for scrutiny and peer review by other member states before they are adopted by national parliaments. The Commission has no power to change national budgets but it would gain more time to influence the content upstream.

Rehn said it would enable the Commission and the European Parliament to identify economic challenges for the EU and the euro zone at an earlier stage and recommend changes.

But it is a potential challenge to fiscal sovereignty and may face watering-down by euro heavyweights France and Germany.

The Commission also proposed a stricter use of existing sanctions, including a cut-off of EU funds to countries that violated the bloc's budget rules.

In a first reaction, German Chancellor Angela Merkel said the proposals went in the right direction and were a means of transparency without being an attack on national budget rights. But she said changes to the EU treaty were still needed to enforce the bloc's budget discipline rules more strictly.

French Finance Minister Christine Lagarde suggested on Tuesday that each government should put its stability and growth program -- a three-year fiscal plan -- to a parliamentary vote before sending it to Brussels. That could make it harder for EU officials to unpick budget measures.

MARKETS CALMING

ECB policymakers, meanwhile, said their weekend decision to buy euro zone government bonds on the open market was having the desired effect in calming markets and curbing speculation.

Any observer will notice that a number of markets which had been functioning very abnormally are gradually operating more normally, ECB President Jean-Claude Trichet said in an interview on France's Europe 1 radio.

ECB executive board member Juergen Stark said euro zone central banks would hold the government bonds they bought until maturity, and the ECB would resist any political pressure to allow higher inflation to ease governments' debt problems. But he acknowledged other economies might take the inflation route.

Economists have said the United States and Britain may accept higher inflation to cope with their debt mountains, leaving the euro zone out of step with a tight monetary policy.

(Additional reporting by Marcin Grajewski in Brussels, Pratima Desai and Jan Harvey in London, Boris Groendahl in Vienna, Crispian Balmer and Sudip Kar-Gupta in Paris, Axel Bugge, Nigel Davies and Elisabeth O'Leary in Madrid; writing by Paul Taylor, editing by Mark Heinrich)