European finance ministers pushed bondholders to provide greaterdebt relief for Greece, denting newfound confidence in Europe'sstrategy for coping with the two-year-old debt crisis.

Euro governments sought to fill a deeper-than-expected hole inGreece's finances by saddling investors with a lower interest rateon exchanged bonds, setting up a confrontation in the runup to aJan. 30 European Union summit.

Brinkmanship over Greece clouded progress toward new fiscalrules and a beefed-up rescue fund, posing a potential setback tothe start-of-year rally in stocks, bonds and the euro.

“Obviously Greece and the banks have to do more in order toreach a sustainable debt level,” Dutch Finance Minister Jan Kees deJager told reporters in Brussels before the final session of atwo-day meeting of European ministers.

The euro slipped after yesterday's meeting, trading at $1.3002at 12:14 p.m. in Brussels, down 0.1 percent. The Stoxx Europe 600index was down 1 percent.

Efforts to shore up Greece, which triggered the crisis, wereflanked by headway on a German-inspired deficit-reduction treatyand indications that a cap on rescue lending might be boosted to750 billion euros ($975 billion) from 500 billion euros.

Finance chiefs balked at an investors' bid for an average 4percent interest rate on new Greek bonds, seeking coupons below 3.5percent for debt to be serviced until 2020 and below 4 percent overthe 30 years of the next Greek package.

The difference between the losses bondholders have offered andthose mentioned by EU finance chiefs “comes down to 10 billion or20 billion euros” over the life of the new bonds, said CarstenBrzeski, an economist at ING Group in Brussels.

“This is just nothing compared to the psychological impact youwould get on Spanish or Italian yields if Greece were to go bust,”Brzeski said in an interview today. “They're going to find a deal,”he said on Bloomberg Television.

The contribution of euro governments and the InternationalMonetary Fund to the package will stay at 130 billion euros aspledged in October.

“It's obvious that the Greek program is off track,” LuxembourgPrime Minister Jean-Claude Juncker told reporters after chairinglast night's meeting of ministers from the 17 euro countries.

'Green Light'

The stalemate is reminiscent of October's bargaining over bondlosses and threatens to spill into next week's leaders' summit. Anaccord with bondholders is essential to a second financing packagefor cash-strapped Greece, which faces a 14.5 billion-euro bondpayment on March 20.

“We have the green light of the euro group to close the dealwith the private sector in the next few days,” Greek FinanceMinister Evangelos Venizelos said.

Greece's struggle intruded on the Brussels meeting afterbondholders made what Charles Dallara, managing director of theWashington-based Institute of International Finance, told AntennaTV constitutes a “maximum” debt-relief offer.

There was no immediate reaction from the IIF, negotiating onbehalf of bondholders, to the euro region's appeal. Dallara isscheduled to hold a press conference at 2:30 p.m. in Zurich.

Failure to wrap up the debt-reduction accord helped drive Greektwo-year yields to an all-time high of 206 percent yesterday. Incontrast to earlier episodes in the crisis, investors wereoptimistic that Greece's travails won't spill over to the rest ofEurope.

Successful short-term debt sales in the past two weeks in Italy,Portugal, Spain, France and Belgium were smoothed by 489 billioneuros disbursed by the European Central Bank in unlimitedthree-year loans to euro-region banks.

Spain today sold 2.51 billion euros of bills, just above itsmaximum target for the sale, as a surge in demand helped bring downborrowing costs.

The country sold three-month bills at a rate of 1.285 percent,the Bank of Spain said, the lowest since March and down from 1.735percent when the securities were last sold on Dec. 20, the daybefore Prime Minister Mariano Rajoy took over. It sold six-monthbills at 1.847 percent, compared with 2.435 percent.

'Correction Mechanism'

The central bank has drawn encouragement from pledges bypolitical leaders to turn Europe into a low-debt economy, enforcedby a fiscal treaty that finance ministers said is on track to besigned in March.

The treaty will create an EU-supervised automatic “correctionmechanism” that would force governments to fix “significant”deviations from a target structural deficit of 0.5 percent of GDP,according to a Jan. 19 draft obtained by Bloomberg News.

“We have reason to be optimistic that we are not only on theright path, but that we will successfully pursue this path for therest of the year,” German Finance Minister Wolfgang Schaeublesaid.

Under German pressure, countries that don't enact the fiscalpact will be denied aid from the permanent rescue fund, theEuropean Stability Mechanism. Finance ministers agreed to set upthe ESM in July, a year ahead of schedule, after reaching acompromise with Finland over how it will award aid.

Finland, one of the four remaining euro-area borrowers rated AAAby Standard & Poor's, pushed through changes to provisions thatcould force it to underwrite loans against its will. Finance chiefswill sign the ESM treaty on Feb. 20, sending it to nationalparliaments for ratification.

Germany, Europe's dominant economic power, gave the strongestsignal yet that it would allow the temporary rescue fund, theEuropean Financial Stability Facility, to lend its full remainingamount before it expires in mid-2013.

Combining the two funds would boost Europe's unspentcrisis-fighting capacity to 750 billion euros. In the past, Germanyhas backed plans to limit the combined lending at 500 billioneuros.

Running the two funds in parallel “is being discussed,” NorbertBarthle, parliamentary budget spokesman for Chancellor AngelaMerkel's Christian Democratic Union, said in an interview yesterdayin Berlin.

The dual use of the funds “is capable of consensus,” AustrianFinance Minister Maria Fekter said today.

'Improved' Firewall

The IMF repeated its plea for the dual-fund option. Speaking onGermany's Deutschlandradio today, IMF Managing Director ChristineLagarde said: “The idea behind the wall is that it is so big thatinvestors — people who finance, people who speculate occasionally —are discouraged because the wall is too big so that the fire cannotgo through. It needs to be improved — the EFSF plus the ESM.”

Meanwhile, the temporary fund will soon be ready to offerinsurance to persuade investors to buy bonds, said Klaus Regling,the fund's manager. It would only intervene if a country such asItaly or Spain requests the backup.

A separate battle brewed over who will take the seat on theECB's Executive Board that will open up when Spain's Jose ManuelGonzalez-Paramo comes to the end of his eight-year term in May.

In a fight between the richer north and the debt-encumberedsouth, Luxembourg is seeking to wrest the seat away from Spain bynominating its central bank chief, Yves Mersch, the longest-serving monetary official in Europe.

Spain proposed Antonio Sainz de Vicuna, head of the ECB's legaldepartment, to hold onto a seat that has been in Spanish handsthroughout the euro. A third contender, Mitja Gaspari, was putforward by Slovenia. The ministers put off a decision until thenext meeting on Feb. 20.

Bloomberg News

Copyright 2018 Bloomberg. All rightsreserved. This material may not be published, broadcast, rewritten,or redistributed.