UK Isolated as Europe Moves Toward Fiscal Union

Europe divided Friday in a historic rift over building a fiscal union to preserve the euro, with a large majority of countries led by Germany and France agreeing to move ahead with a separate treaty, leaving Britain isolated.

Twenty-three of the 27 leaders agreed to pursue tighter integration with stricter budget rules for the single currency area, but Britain said it could not accept proposed amendments to the EU treaty after failing to secure concessions for itself.

After 10 hours of talks, all 17 members of the euro zone and six countries that aspire to join resolved to negotiate a new agreement alongside the EU treaty with a tougher deficit and debt regime to insulate the euro zone against the debt crisis.

Not Europe, Brits divided. And they are outside of decision making. Europe is united, Lithuanian President Dalia Grybauskaite said in blunt English on arriving for the second day of the bloc's eighth crisis summit this year.

European Central Bank President Mario Draghi called the decision a step forward for the stricter budget rules he has said are necessary if the 17-nation euro zone is to emerge stronger from two years of market turmoil.

It's going to be the basis for a good fiscal compact and more discipline in economic policy in the euro area members, Draghi said. We came to conclusions that will have to be fleshed out more in the coming days.

German Chancellor Angela Merkel said she was very satisfied with the decisions. The world would see that Europe had learned from its mistakes and avoided lousy compromise, she said.

Merkel, Europe's most powerful leader, said she had not given up hope that Britain would eventually agree to change the EU treaty to anchor stricter budget discipline.

Active ECB support will be vital in the coming days.

Irish Europe Minister Lucinda Creighton said Dublin and many other member states expect the central bank to take a more pro-active approach to the debt crisis in the weeks ahead. Traders said the ECB bought Italian bonds on Friday to steady markets.

The euro, shares and commodities fell in Asia because of growing doubts about whether Europe can forge a convincing financial firewall to arrest contagion in bond markets, but the currency regained ground in Europe and European stocks were narrowly higher.

Markets need to know where we are going, how we're getting there, and they need to know how long it's going to take. Where we are going, I believe, is toward a more unified and serious Europe in budgetary terms, said Francois Perol, chief executive of BPCE, France's second largest bank.

Asked if the euro was safe now, Polish Prime Minister Donald Tusk said: I'm not sure.

In the run-up to the summit, Draghi's use of the term fiscal compact had spurred hopes that the ECB would be prepared to engage in massive buying of bonds from distressed euro zone states, an interpretation he discouraged on Thursday.

German Chancellor Angela Merkel and French President Nicolas Sarkozy had wanted to get the whole EU to agree to change the Lisbon treaty so that stricter budget and debt rules for eurozone states could be enshrined in the bloc's basic law.

But Britain, which is outside the euro zone, refused to back the move, saying it wanted guarantees in a protocol protecting its financial services industry. Sarkozy described British Prime Minister David Cameron's demand as unacceptable.

Cameron hinted London may try to prevent the others from using the executive European Commission and the European Court of Justice, saying: Clearly the institutions of the European Union belong to the European Union, they belong to the 27.

HISTORIC SUMMIT

As a result, Sarkozy and Merkel said the intention was now to forge an intergovernmental treaty among the euro zone countries and any others that wanted to join. They indicated that could be up to 25 countries in all, with only Britain and perhaps Hungary left outside the tent for now. Sweden and the Czech Republic said they would consult their parliaments.

This is a summit that will go down in history, said Sarkozy. We would have preferred a reform of the treaties among 27. That wasn't possible given the position of our British friends. And so it will be through an intergovernmental treaty of 17, but open to others.

Herman Van Rompuy, the president of the European Council and the summit chairman, focused on the success in securing agreement for tighter fiscal limits, including the need for countries to bring budgets close to balance.

It means reinforcing our rules on excessive deficit procedures by making them more automatic. It also means that member states would have to submit their draft budgetary plans to the (European) Commission, he said.

On treaty change, Van Rompuy said the new treaty would involve the euro zone and at least six other countries, with two more waiting for a mandate to participate.

An inter-governmental treaty can be approved and ratified much more rapidly than a full-fledged treaty change, and I think speed is also very important to enhance credibility, he said.

But it could still take months of wrangling, with countries like Finland and Slovakia opposing a Franco-German drive to take decisions on future bailouts by a supermajority to avoid being taken hostage by a single small country.

LAST-CHANCE SALOON?

In a meeting billed as a last chance to save the euro, with financial markets unconvinced by policymakers' efforts to tackle the region's problems so far, the leaders also took several critical decisions on the permanent bailout fund, the European Stability Mechanism, which will come into force in July 2012.

The ESM's capacity will be capped at 500 billion euros ($666 billion), less than had been suggested was possible before the summit, and the facility will not get a banking license, as Van Rompuy originally had proposed, due to German opposition.

It also was agreed that EU countries would provide up to 200 billion euros in bilateral loans to the International Monetary Fund (IMF) to help it tackle the crisis, with 150 billion euros of the total coming from the euro zone countries.

We can be very pleased at the result, IMF Managing Director Christine Lagarde said as she left the summit.

Cameron's decision to stay out of the treaty-change camp could spell problems for Britain, although it was expected to find favor with the increasingly vocal eurosceptic wing of his Conservative party initially.

The danger is that if a large majority of EU countries do push ahead with deeper integration, it could involve changes to the single market and financial regulation, both of which could have a profound impact on the British economy.

Cameron was clumsy in his maneuvering, a senior EU diplomat said. It may be possible that Britain will shift its position in the days ahead if it discovers that isolation really is not a viable course of action, diplomats said.

At the same time, if Britain does stay out, not only could it mark an irrevocable split with the European Union, which it joined nearly 40 years ago, but it will leave the rest of the EU and euro zone to institutionalize a 'two-speed' Europe.

Earlier, the plight of Europe's banks was thrown into sharp relief. The European Banking Authority told them to increase their capital by a total of 114.7 billion euros, significantly more than predicted two months ago.

A Reuters poll of economists found that while 33 out of 57 believe the euro zone will probably survive in its current form, 38 of those questioned expected this week's summit would fail to deliver a decisive solution to the debt crisis.

(Additional reporting by Catherine Bremer in Marseille, John O'Donnell and Jan Strupczewski in Brussels, Eva Kuehnen and Sakari Suoninen in Frankfurt, and Terhi Kinnunen in Helsinki; Writing by Paul Taylor; Editing by)