Eurozone leaders agreed at an emergency summit on Thursday to give their financial rescue fund sweeping new powers to help Greece overcome its debt crisis and prevent market instability from spreading through the region.
French President Nicolas Sarkozy said leaders of the 17-nation currency area had agreed to ease lending terms to Greece, Ireland and Portugal, while private investors would voluntarily swap their Greek bonds for longer maturities at lower interest rates to help Athens.
Acknowledging that the rescue package might lead credit rating agencies to declare Greek debt in limited default - the first such event in the euro's 12-year history - Sarkozy said eurozone nations stood ready to protect Greek banks from the fallout, by providing credit guarantees if needed to ensure the banks can still obtain liquidity from the European Central Bank.
"We have agreed to create the beginnings of a European Monetary Fund," Sarkozy told a news conference after eight hours of talks on widening the remit of the rescue fund, the European Financial Stability Facility.
European Council President Herman van Rompuy, who chaired the fifth summit on the crisis since February, said the leaders agreed the EFSF would be allowed to buy bonds in the secondary market if the ECB deemed that necessary to fight the crisis.
The EFSF would also be allowed for the first time to give states precautionary credit lines before they were shut out of credit markets, and lend governments money to recapitalise banks -- both moves which Germany blocked earlier this year.
The expanded role of the EFSF is designed to prevent bigger euro zone states such as Spain and Italy from being shut out of the markets in the event of a Greek default.
Earlier, the ECB signalled in a policy reversal that it was willing to let Greece default temporarily as part of the plan, which involves longer and cheaper emergency loans to the euro zone's three bailout states, a debt swap and a bond buyback. A proposal to raise money for Greece by imposing a new tax on banks was rejected.
The summit accord was based on a common position crafted by German Chancellor Angela Merkel and Sarkozy in late night talks in Berlin on Wednesday with ECB President Jean-Claude Trichet.
City A.M. Reporter