Merkel stands ground under French pressure

Angela Merkel today reiterated her preference for treaty change, as well as her opposition to both eurobonds and a stronger role for the European Central Bank in stemming the eurozone's sovereign debt woes – even as bailed-out Portugal had its credit rating downgraded to junk status and signs emerged that Germany is not immune to the impact of the crisis.

The German chancellor, meeting French President Nicolas Sarkozy and newly-installed Italian premier Mario Monti in Strasbourg, said eurobonds were "not needed and not appropriate", just a day after the European Commission put forward proposals for eurozone countries to issue debt jointly. So-called stability bonds would allow countries such as Italy and Spain to borrow money more cheaply because their debt would be backed by stronger economies like Germany, Finland and the Netherlands.

But Merkel said: "It would be a completely wrong signal to ignore those diverging interest rates because they're an indicator of where work still needs to be done." Germany is concerned that pooling debts would remove the incentive for sound finances and structural reform in southern European countries.

In the face of pressure from France, which fears losing its triple-A credit rating, Merkel also insisted that the ECB retain its full independence and focus solely on maintaining price stability, rather than stepping in as a lender of last resort. Ahead of the meeting, French Prime Minister Francois Fillon outlined the division: "We are struck with a major difficulty, that is to convince Germany that we should arm the eurozone with an instrument of defence for our currency through a certain evolution of the role of the central bank."

But speaking alongside Merkel, Sarkozy said that no "positive or negative" demands would be made of the ECB, suggesting that the Chancellor had come out on top. Merkel's refusal to alter her position came despite yesterday's weak sale of German bonds, which suggested that the crisis contagion was spreading to the core of the single currency area. Today the United Kingdom sold bonds at a lower interest rate than Germany for the first time since March 2009.

Sony Kapoor, managing director of the economic think-tank Re-Define, warned that the "myth of German economic invincibility is starting to be questioned".

"UK and United States bonds, with much worse fundamentals and higher inflation rates than Germany are trading below long-term German bonds simply because the ECB says it will not play the role the Bank of England and US Federal Reserve do. Unless the crisis is decisively addressed, the flight to safety towards German bonds may be overwhelmed by a flight of euro denominated assets".

Merkel and Sarkozy will present proposals for treaty changes before European Union leaders meet on December 9, with the aim of drawing the eurozone into a closer fiscal union to prevent countries building up excessive debts and deficits. But the lack of a short-term fix caused the euro to fall from $1.338 to a low of $1.332 as the three leaders spoke. Stock markets across Europe were down by between 0.3 and 1 per cent and the yield on Italian bonds again rose above the danger level of 7 per cent.

Today, Fitch Ratings announced that it was lowering Portugal's credit score from BBB- to BB+, the highest non-investment grade, citing high levels of debt, large fiscal imbalances and an adverse outlook as its reasons. In a statement, the rating agency said Portugal's economy was likely to contract by 3 per cent in 2012 and recession would make the government's deficit reduction plan "much more challenging" – despite the government's "strong" commitment. Fellow rating agency Moody's similarly downgraded Portugal to junk in July.

Kapoor said the move highlighted the limits of austerity policies and how hard it would be for troubled economies to pull themselves out of the crisis. "Unless something drastic is done in the next few weeks, the trickle of sovereign and bank downgrades will soon turn into a flood."

Meanwhile Portugal was hit by its biggest general strike for 30 years as workers protested against austerity measures – closing schools and factories, and bringing public transport to a halt.

And there have also been clashes between protesters and police in Greece, where 15 people were arrested following a demonstration outside one of the country's biggest power producers in Athens. There is widespread anger at the introduction of a property tax which is to be collected by the Greek electricity board.