EU makes bold moves to boost euro

European Union leaders meeting in Brussels surprised and impressed markets worldwide Friday by taking unexpectedly decisive action to boost confidence in the struggling euro common currency and committing to stronger economic and political integration over the next few years.

Expectations had been low that the 27 EU presidents and prime ministers would do more than highlight the deep divisions between heavily indebted nations mired in recession — such as Italy, Spain and Greece — and the bloc’s economic powerhouse, Germany.

After an all-night diplomatic wrestling match in which French President Francois Hollande played referee, according to European news reports, the EU leaders announced a plan to use European Central Bank surplus cash to directly recapitalize insolvent Spanish banks and to buy government bonds from Italy and Spain at markedly lower interest rates than they have been paying on the open market.

Investors were clearly buoyed by the news at the end of the two-day meeting. Markets throughout Europe rallied strongly after weeks of crisis-fueled selloffs, with the euro gaining 2% against the U.S. dollar and stock markets in Spain and Italy both posting about 5% gains. The cost of borrowing also dropped significantly for the two countries, in a sign that lenders’ worries have been at least temporarily eased.

U.S. markets also rose on the news, with the Dow Jones industrial average gaining 278 points.

German Chancellor Angela Merkel had resisted calls for direct lending by the European Central Bank to banks in the 17 Eurozone countries, which share the euro currency. She had insisted that the bloc would first need to create centralized controls over individual nations’ banking and finance policies.

That stance led to fear that the Brussels summit would not act to deflate the swelling debt crisis, even at the risk of steering more nations toward the need for bailouts and driving some euro users out of the prestigious currency club.

At the urging of Spain and Italy, the EU leaders agreed to pump bailout funds directly into Spanish banks rather than make loans to the Madrid government that would add to Spain’s already outsized national debt. They also agreed to waive the usual provision that ECB loans have “seniority” over the borrowing states’ other obligations, a status that made private investors wary of lending with a lower priority for repayment.

With central bank cash to be available within 10 days to buy government bonds at about 1% annual interest, Italy and Spain should be able to raise capital for paying bills and servicing debt without being pushed into insolvency and forced to seek bailouts. Rome and Madrid have had to pay 6% and 7% yields respectively on their 10-year bonds in recent weeks because of declining market confidence in euro-denominated investments.

Italy and Spain are the Eurozone’s third- and fourth-largest economies, and financial analysts contend that their debts would overwhelm the EU rescue funds that have already been tapped to bail out Greece, Portugal and Ireland.

Merkel returned to Berlin after the summit to urge lawmakers to endorse a new EU permanent rescue fund and a fiscal compact that obliges all Eurozone states to keep their budget deficits low. Lawmakers overwhelmingly approved the measures that Merkel took a leading role in creating, which are designed to enshrine euro users’ commitment to austerity and fiscal discipline.

In her address to the lower house, she cast her concessions in Brussels on direct bank bailouts as necessary for the collective good and a “sensible decision” backed by tough conditions to be imposed on the borrowers.

After a working dinner Thursday night in Brussels, when the EU leaders appeared to be winding down their meetings with only a token agreement to spend $149 billion to spur growth in the recession-plagued states, Spanish Prime Minister Mariano Rajoy and his Italian counterpart, Mario Monti, insisted that the group work through the night to come up with bolder moves to calm jittery markets.

In addition to the short-term borrowing relief arranged for Italy and Spain, the 14-hour negotiating marathon produced commitment to a road map, laid out this week, for integrating fiscal and banking policies within the currency union.

European Council President Herman Van Rompuy said details of the plan will be worked out after a study is concluded in October on four “building blocks” to unify financial, budgetary and economic policies and to ensure “democratic legitimacy and accountability” in the Eurozone. The latter goal appears to address suggestions for a collectively guaranteed liability for euro-denominated government debts.

“Everyone here has agreed that a stable euro is in the interest of the whole European Union,” said European Commission President Jose Manuel Barroso, alluding to EU members such as Britain, Sweden, Denmark and Poland, which don’t belong to the currency union but suffer reduced trade and other spillover when the euro users are in recession.

In a statement posted on the European Union website, Barroso said EU officials will work over the summer to draft legislative proposals for integrating finances and budgeting, steps he described as necessary “to match our growing interdependence and need for financial stability.”

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