Eurozone debates buying bonds of struggling nations

(BRUSSELS) - Eurozone governments mulled Thursday whether to use their rescue fund to buy debt directly from nations hit by high borrowing costs, diplomats said, a move that could ease pressure on Italy and Spain.

While European Union leaders began a two-day summit aimed at getting to grips with the debt crisis, treasury officials held separate talks in Brussels to try to curb soaring Italian and Spanish borrowing costs.

"It is under discussion, but we must wait to see if it will materialise," a diplomat said on condition of anonymity. A second diplomat confirmed the talks were taking place.

Finnish leaders said one option could involve so-called covered bonds backed by tangible assets like property or future sources of revenues, such as taxes.

The European Financial Stability Facility (EFSF) can already buy bonds issued by heavily indebted nations in secondary markets, if a government requests such intervention, and following a European Central Bank assessment.

Italy wants more flexibility to activate the EFSF's bond-buying operations, however.

The fund can also directly buy government bonds in primary markets if a eurozone nation already benefits from a negotiated bailout programme.

While Spain has now bowed to pressure and asked for aid for its banks, Italy wants the EFSF to act without Rome having to go cap in hand to its partners.

Structural reforms and budget cuts are usually demanded in return for aid.

Finnish Prime Minister Jyrki Katainen called for the EFSF to eventually provide a backstop for covered bonds, which could allow countries to access private equity at lower rates without eurozone partners having to intervene directly.

"This is what Finland did in a difficult economic situation in the 1990s and it is standard practice for banks today," Katainen said.

"The EFSF or ESM could stand ready to intervene in the primary market to facilitate successful issuance of the covered bonds," he added in a reference to the European Stability Mechanism, the permanent EU rescue fund due to take over from the EFSF.

But the Finnish leader also stressed that "strong policies by the member states concerned would be important to ensure the stability of the euro area."

A member of the Italian delegation said the Finnish proposal was "insufficient" and could have the negative effect of dissuading investors from buying uncovered debt, for which interest rates might then climb even higher.

It was thus "not an alternative" to mechanisms sought by Rome, the official said.

The financial situations in Italy and Spain are to be the focus of a lunch between eurozone leaders on Friday.

Italy had to pay investors higher rates of return at a five and ten-year bond sale on Thursday, with the rate on ten-year bonds rising to 6.19 percent from 6.03 percent at the last comparable auction on May 30, the Bank of Italy said.

French President Francois Hollande called for "very quick solutions to support the countries facing the biggest problems in the markets" as he arrived for the two-day summit on Thursday.

Finnish European affairs minister Alexander Stubb said later that several options were under discussion, and added: "At the end of the day, we'll see what's going to fly."