European Central Bank council member Ewald Nowotny suggested thebank may compromise and allow a temporary Greek default asofficials scramble to fix a sovereign debt crisis that's spreadingto Italy and Spain before a leaders' summit in two days.

As Spanish financing costs surged at a 4.45 billion euro ($6.31billion) treasury bill auction today, policy makers are trying toease a split that's pushed interest rates on Spanish and Italian10-year debt above 6 percent for the first time since the eurodebuted 12 years ago. The ECB has until now argued that any Greekdefault could spark a new financial crisis, derailing a German pushto make investors help foot the bill for a second bailout of thecountry.

“Nowotny is well known as someone who talks a lot,” said NickKounis, head of macroeconomic research at ABN Amro Bank NV inAmsterdam. “He might be revealing that there's a little bit moreflexibility than what was perhaps assumed. On the other hand, wehave to be a bit careful with Nowotny. I'd be cautious.”

Nowotny, who heads Austria's central bank, issued a statementtoday concerning the “interpretation” of his earlier comments in aninterview with CNBC. He is in “complete agreement” with ECBPresident Jean-Claude Trichet that the aim is to “avoid anysituation that would make it impossible for the ECB to continue toaccept Greek sovereign bonds as collateral,” the statementsaid.

'Range of Options'
In the CNBC interviewbroadcast this morning, Nowotny said there's “a full range ofoptions and definitions, from a clear-cut default, selectivedefault, credit event and so on.”

“This has to be studied in a very serious way,” he said. “Thereare some proposals that deal with a very short-lived selectivedefault situation that will not have major negativeconsequences.”

The comments helped boost financial markets amid speculation asolution to the crisis will be found. The euro rose to $1.4197 at12:20 p.m. in Frankfurt, up from $1.4028 yesterday. Yields onSpanish and Italian 10-year bonds retreated from euro-era highs asstock markets rallied.

Spanish yields fell 17 basis points to 6.10 percent as of 12:35P.m. in London, while Italy's yield dropped 23 basis points to 5.72percent. Greek two-year yields surged to 38.5 percent.

Eurobond Fix
Some finance ministers havestarted to zero in on Eurobonds as part of the fix for a crisisthat has ricocheted through the euro region for more than 18 monthsand is now threatening to engulf two of its biggest members. Whilejointly issuing bonds with Germany may help debt-laden nations tapmarkets at lower interest rates, it could also raise borrowingcosts for Europe's largest economy.

European Union leaders are meeting on July 21 to hammer out asolution to the Greek debt crisis, which has already spread toIreland and Portugal. While Germany wants private investors toparticipate in a second bailout package for Greece, Trichet saysthe central bank won't accept Greek government bonds as collateralfor loans in the event of a default or “credit event.”

By contrast, Nowotny said it's up to the Frankfurt-based centralbank to decide what collateral it accepts and it “should not betotally dependent on rating agencies.”

'Our Decision'
“It is our ownresponsibility, our own decision,” he told CNBC. “We have provedthis in the case of Ireland, Greece and Portugal, with regard towhat kind of collateral we accept. So there is a certain case forindependence. But of course, not with regard to rating agencies butwith regard to our own statutes, there are limitations.” Hereiterated that view in his subsequent statement.

EU President Herman van Rompuy has asked leaders to meet inBrussels to discuss “the financial stability of the euro area as awhole and the future financing of the Greek program.” Yesterday,stocks declined around the world, the euro fell and the cost ofinsuring European sovereign debt rose to records amid concern theeuro region isn't any closer to solving the crisis a year afterGreece's initial rescue.

A summit was originally mulled for last week before beingpostponed amid German fears it would backfire without a pact onprivate-sector involvement. Germany's government says no extra aidis possible without bondholders staying exposed to Greek debt.

'Continue to Fight'
“I don't expectEuropean leaders to reach a decision this week,” said David Kohl,deputy chief economist at Julius Baer Group in Frankfurt. “They'llcontinue to fight over whether to include bondholders or not.Still, a Greek debt restructuring wouldn't be a solution to theproblem.”

The euro-region recovery is losing momentum as leaders struggleto contain the crisis. In Germany, Europe's largest economy,investor confidence dropped to the lowest in 2 1/2 years in July,the ZEW Center for European Economic Research in Mannheim saidtoday. European economic confidence dropped in June andmanufacturing growth slowed.

Nowotny said a full Greek default must be avoided. “That wouldhave very grave consequences, especially with regard to the ECB andthe ability of the ECB to accept Greek collateral,” he toldCNBC.

Bloomberg News

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