Battle begins over 'refounding' of Europe

(PARIS) - The European Union began a nine-day battle on Thursday over federal-style changes to save the eurozone, with French President Nicolas Sarkozy saying that Europe needs to be "refounded".

While Sarkozy said he and German Chancellor Angela Merkel would meet on Monday in Paris to announce their joint debt crisis plan, he said they wanted a new EU treaty.

"Europe must be refounded," Sarkozy said in a landmark speech on the eurozone crisis in the southern city of Toulon.

Merkel is to lay down her vision of how the EU should work, and her conditions, in a speech to the Bundestag lower house of parliament on Friday.

Meanwhile, the European Central Bank and Bank of England cooled the air after shock action by central banks to shore up the global system boosted markets.

The new ECB president Mario Draghi sent a strong message that there is no magic wand, telling the European Parliament that the central bank will not act beyond rules laid down by EU treaties and that its purchasing of devalued government bonds is "temporary and limited".

The bank "should not be asked to do things that are not within the treaty", he told the European Parliament. "It would be not legal, but also a mistake because... it would undermine the credibility in the ECB," he added.

Bank of England governor Mervyn King said that joint central bank action launched on Wednesday was merely "some temporary relief to liquidity problems" and that the underlying causes had to be "tackled directly by the governments involved".

Britain is not a member of the eurozone, but as a member of the European Union and a financial centre, is highly exposed to the eurozone debt crisis, and King said the BoE had prepared a plan in case the single currency area breaks up.

Germany strongly backs the ECB line, arguing that the first condition of a solution to the debt crisis is cast-iron federal-type corsets controlling national budgets and economic reforms to release growth.

This policy was laid down again by Foreign Minister Guido Westerwelle who said in Ouest France newspaper that "we have no time to lose" up to the EU summit on December 8 and 9.

"What we need first and foremost are automatic sanctions when (budget) stability rules are broken," he said, adding that new rules should open the way for a country to be taken to the European Court for breaches.

France however has pushed for the ECB to act as a lender of a last resort to eurozone governments to ensure that panicky markets do not push states into into insolvency.

Sarkozy said however that while the European Central Bank "is and will remain independent" that he believes it will act to counter the threat of the eurozone crisis.

"I'm convinced that faced with the risk of deflation that is threatening Europe the central bank will act," Sarkozy said, adding that it was up to the ECB to decide when and how to act.

The catastrophic risks that Europe is running were highlighted by the EU's Economy Commissioner Olli Rehn.

He declared that monetary union "will either have to be completed through much deeper integration or we will have to accept a gradual disintegration of over half a century of European integration".

Market tension remains high on uncertainty about whether in nine days EU leaders can at last come up with a convincing big-bang solution to stop the crisis now threatening the EU itself and the global financial system.

The euro firmed but European stocks slipped after a global surge in relief at the central bank action to ease distress in parts of the banking system. Stocks were mixed in afternoon trading on Wall Street.

Ratings agency Fitch said that general risks across Europe had worsened, with increased pressures on bank balance sheets, and possible increased "stress on sectors with significant refinancing requirements".

Standard and Poor's rating agency said it now expected the eurozone to slip into a mild recession in the first half of next year and cut its forecast for eurozone growth next year to 0.4 percent.

Italy, at high risk of being the next and by far the biggest eurozone domino to need a bailout, said it is at risk of entering recession.

This warning came as the new Prime Minister Mario Monti is putting together his master plan to reform the budget after consultations with EU officials, for presentation to his cabinet on Monday.

Germany and France have warned that if Italy's finances become unsustainable the eurozone will break up.

On the eurozone bond market, France raised money on easier terms but Spain had to pay increased rates at a bond auction.