European leaders return to work this week seeking to buy timefor the Spanish and Italian governments to wrest control over theirdebt and rescue the single currency from fragmentation in its 10thanniversary year.

Some 157 billion euros ($203 billion) in debt will mature in the17-member euro area in the first three months of 2012, according toUBS AG. By the end of that period, leaders have pledged to draft astricter rulebook for controlling government spending. GermanChancellor Angela Merkel and French President Nicolas Sarkozy willmeet in Berlin Jan. 9 to work out details.

“The road to overcoming this won't be without setbacks, but atthe end of this path Europe will emerge stronger from the crisisthan before,” Merkel said in a New Year's speech broadcast Dec. 31.Merkel, whose first official appointment is on Jan. 5, reiteratedthat her government will do “everything” to bring the euro out ofthe slump.

Ten years after euro bank notes replaced national currencies onJan. 1, 2002, the euro has for the first time recorded twoconsecutive annual losses against the U.S. dollar while plunging toa record low against the yen. That raises the pressure on euroleaders as they struggle to hold the monetary union together in theface of credit downgrades, European Union splits and a loomingrecession that might compound rising debt.

European shares rose on the first trading day of 2012, with theStoxx Europe 600 Index up 0.27 percent as of 10:06 a.m. in Berlin.The gauge slumped 11 percent last year.

The euro slid 0.1 percent to $1.2944 after earlier dropping asmuch as 0.3 percent. The single currency lost 3 percent against thedollar last year, ending at $1.2961, a decline of 13 percent fromits 2011 high of $1.4830 on May 2. It lost 3.2 percent in the lastquarter.

The latest crack in Europe's crisis-fighting plans appeared onDec. 30, when Spain's new government said 2011's budget deficitwould reach 8 percent of output, 2 percent more than the previousgovernment had projected and more than the 6.9 percent expected byeconomists surveyed by Bloomberg. Prime Minister Mariano Rajoyresponded by unveiling a new package of spending cuts and taxincreases.

Still, the key to the euro's survival may lie with Italy, thegroup's third-largest economy and the second most-indebted afterGreece. The government in Rome must repay 53 billion euros in debtin the first quarter, about a third of the euro area's total amountfor the period, after Prime Minister Mario Monti passed anemergency budget package aimed at curtailing borrowing costs.

Italian Yields

Italy's 10-year yield ended 2011 near the 7 percent mark thatled Greece, Ireland and Portugal to seek bailouts. Spain'sequivalent yield finished the year just above 5 percent. Italian10-year yields dropped 13 basis points to 6.97 percent today, whileSpanish yields were little changed at 5.10 percent.

“If the Italian yields start to rise, you could quickly turn amanageable situation into an insolvent one,” Michael Spence, aprofessor of economics at New York University and a Nobel laureate,said on Bloomberg Television Dec. 28. “Italy needs time and Europeneeds to help buy them some of the time.”

German Finance Minister Wolfgang Schaeuble echoed that strategy,telling the Bild newspaper yesterday that European rescue funds canonly “buy time” before indebted states take “the necessary measuresto win back confidence.”

Sarkozy said that the French government will turn from budgetfighting to economic growth and unemployment in 2012, which will be“the year of all risks and of all possibilities,” he said Dec. 31in his fifth New Year's address, the last before he faces are-election contest in May. Sarkozy will meet with Italy's Monti inParis on Jan. 6.

In his New Year's message to Greek citizens, Prime MinisterLucas Papademos said his nation will confront a “difficult” 2012and said that the “next three months will be particularlycrucial.”

Papademos, appointed on Nov. 11 as head of a government backedby three of the five parliamentary parties, is trying to secureloans under a 130 billion-euro bailout for Greece agreed to inOctober by EU leaders before elections are held. Measures includenegotiating a debt swap with private creditors that will cut 100billion euros off Greece's burden.

As Europe's leaders tinker at a new budget framework and craftthe so-called firewall that will prop up ailing states, BundesbankPresident Jens Weidmann said that the European Central Bank won't“step into the breach for fiscal policy.”

ECB Limits

“We have to make it clear where our legal, but also our reallimits, are,” Weidmann, who is a council member of theFrankfurt-based ECB, told Tagesspiegel newspaper yesterday.

Fiscal and monetary efforts could be hampered by a shrinkingeconomy in the euro area, which would crimp tax revenues and fuelunemployment. The economy of the 17-nation area will shrink byabout 0.7 percent this year, said Howard Archer, an economist atIHS Global Insight in London.

“We expect eurozone recession to occur in late-2011 and thefirst half of 2012 in the face of the ongoing eurozone sovereigndebt crisis,” Archer wrote in a Dec. 30 note to clients. “It isvital that eurozone policymakers get a real grip on mattersquickly.”

Bloomberg News

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