05/12/2011 13:23 GMT

Markets Cheer As Nicolas Sarkozy And Angela Merkel Show Unity On EU Treaty Change

European Markets have closed up after a meeting between Nicolas Sarkozy and Angela Merkel saw the pair propose sweeping changes to the European Union constitution that could - if implemented - prevent a re-run of the sovereign debt crisis that has paralysed the eurozone and pushed the single currency to the brink of collapse.

"It is very important that we work as closely together as possible," Merkel said. "We are in a difficult situation and we need to regain trust, as the belief that we can be taken at our word has suffered."

"This package shows that we are absolutely determined to keep the euro as a stable currency and as an important contributor to European stability."

The proposed treaty revision calls for automatic sanctions for countries that run government deficits at greater than 3% of GDP, a key point for the German government, who have argued that defining fiscal targets without any mechanism to penalise countries that step outside the boundaries.

This, in theory, would mean that the kind of runaway spending plans that drove Italy to the brink and Greece beyond it would be impossible.

The proposed changes also address some of the key issues with the response so far. By saying that only a qualified majority of 85% would be needed to pass reforms, the travelling circus of country-by-country votes to ratify important legislation would be sped up. The likelihood of this summer's scenario, where individual countries threatened to derail the passage of a bill to reform the European Financial Stability Facility (EFSF).

Monthly summits between leaders might also reduce the backlog of issues that has led to policy paralysis in Europe. Adding structure to the ad hoc scheduling of meetings might also alleviate some of the sense of crisis that builds up ahead of each emergency summit.

The European Central Bank will not become a lender of last resort, the pair said. This should not rule out the bank participating more aggressively in bond markets, but it does remove a potential backstop that the markets would have liked to see.

"Haircuts" on government debt agreed with the private sector - such as in Greece - would not be repeated for other countries, which should put some steel behind nascent interest in peripheral bonds.

"Greece was a one-off case, and the voluntary debt write-down is a one-off," Merkel said. "From now on we want questions of state insolvency to be handled according to IMF rules."

The creation of a European Monetary Fund - presumably backed either by the ECB or sovereign bonds issued by the eurozone countries themselves, might go some way to fill in the gap.

Nevertheless, the show of unity - and the fact that France seems to have conceded on key points to Germany - saw markets extend earlier gains. The French CAC-40 closed up by 1.29%, the German DAX was up by 0.52% and the FTSE-100 gained 0.35%.

Markets were also propped up by positive newsflow from Italy, where a new austerity package was pushed through overnight; and from Belgium, where a new government is close to formation.

A long week of negotiations beckons, and the concern that eurosceptic elements in governments in the UK, Finland or the Netherlands could throw a spanner in the works could be in assuaged by the promise from Sarkozy that, even if the 27-member union would not agree to the new measures, the 17 eurozone countries might push on regardless.

"Things cannot continue as they have done up until today," Sarkozy said. "Our preference is for a treaty among the 27, so that nobody feels excluded, but we are open to a treaty among the 17, open to any state that wants to join us."

Five other things you should read about the euro crisis:

Euro Disziplin May Store Up Trouble - Hugo Dixon (Reuters)

Germany Is Winning The Debate On Fiscal Union - Gavyn Davis (FT)

Banker Rocks EU Talks - Max Colchester (WSJ)

Better Merkozy Than Bismarck And Daladier - Michael White (Guardian)

The Eurozone Won't Sink Or Swim, It Will Bob Along - Ian Bremmer (FT)