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Euro under pressure as EU summit optimism fades

By Gabriele Steinhauser

Associated Press

Published: Thursday, Dec. 15 2011 8:31 a.m. MST

Firefighters take part in a protest against spending cuts in Catalonia's public services in Barcelona, Spain, Wednesday Dec. 14, 2011. The euro is falling against the dollar on renewed fears that European leaders won't be able to solve the region's growing debt crisis. Spain's jobless rate stands at a 15-year high of 21.5 percent, the highest in the eurozone.

Emilio Morenatti, Associated Press

FRANKFURT, Germany — The euro slid to an 11-month low and borrowing costs spiked Wednesday for heavily indebted Italy, as economic realities dispelled the last wisps of optimism left about an EU deal aimed at containing Europe's debt crisis.

The market verdict — that Europe's debt problems are still unsolved — comes after five days of accumulating questions about whether the deal's new limits on debt and added contributions to the International Monetary Fund will take full effect.

There's also the recognition that last week's summit deal:

— Doesn't reduce existing government debt levels;

— Doesn't do much to promote the long-term growth that would shrink those burdens;

— And didn't create a financial backstop big enough to convince markets that all European countries will pay their debts no matter what.

The loss of confidence comes as experts from the 17 nations that use the euro started reworking the summit deal into a new treaty late Wednesday in Brussels, which will be followed Thursday by a get-together of delegates, a European official said, speaking on condition of anonymity because the talks are confidential.

The euro traded below $1.30 for the first time since January 12, hitting a low of $1.2973. Some of that is loss of confidence in the assets of eurozone nations, but it's also the result of two quarter-point interest rate cuts from the European Central Bank. The cuts lower the return on euro-denominated holdings and can induce investors to move money elsewhere.

One of the reasons why the euro not fallen further against the dollar this year, despite the pressures heaped on it by the debt crisis, is that interest rates in Europe have been so much higher than those in the U.S., where the Federal Reserve has kept its main interest rate near zero percent.

That interest rate differential has helped offset the concerns investors naturally felt as the European debt crisis raged and threatened to undermine Europe's banking system and the currency itself.

At Italy's last bond auction of the year, investors demanded even more money to lend to the eurozone's third-largest economy. Italy paid 6.47 percent interest to borrow €3 billion ($3.95 billion) for five years at a bond auction, up from 6.30 percent just a month ago.

The higher rates reflected investors' fears over the inadequacy of last week's agreement to keep eurozone governments from piling up more debt in the future. Italy has a staggering €1.9 trillion ($2.5 trillion) in outstanding debt, and its economy is too large for Europe to bailout, like smaller nations Greece, Ireland and Portugal have been.

The new treaty aims to impose tighter rules on how much money eurozone governments can spend. Leaders agreed to include automatic limits in their national constitutions, which would limit deficits to 0.5 percent of economic output in regular economic times. It also is expected to make penalties for overspending governments more automatic and force governments to spell out how they will reduce their big debts and what they are borrowing on the bond markets.

The debt treaty does provide some assurance that European governments are working together to address the euro's flaws in the long-term. But it will not be signed until March at the earliest, and a text must first win approval from the 17 eurozone governments and nine others that the EU hopes will sign. Britain has said it will not.

Issues remain, however, including how the new accord will interact with the existing debt provisions of the basic treaty of the European Union — which remains unchanged — and whether it can legally rely on EU institutions, such as the European Commission and the European Court of Justice, to enforce the new rules.

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