Eurozone relaxes rules of 'unravelling' stability pact

The guidelines governing the euro – labelled "stupid" by the European Commission president – underwent sweeping changes yesterday.

After weeks of speculation, the European Commission announced plans to loosen the economic straitjacket on EU economies by interpreting guidelines more flexibly and taking into account the countries' levels of debt.

The move comes at the end of a year in which criticism of the so-called Stability and Growth Pact has grown steadily louder. While the currency itself has strengthened recently on the foreign exchanges, the rigidities of its rulebook have been exposed cruelly by the economic slowdown.

With Germany and Portugal now in breach of public-deficit targets, and France and Italy giving cause for concern, the pact has, in effect, unravelled, less than four years after the launch of the single currency.

At a press conference yesterday, Pedro Solbes, the EU's economic and monetary affairs commissioner, reiterated his commitment to the central pillar of the pact: the budget deficit ceiling of 3 per cent of gross domestic product (GDP). This is designed to underscore the central objective of keeping public spending, and therefore inflation and interest rates, low.

All countries must also work towards balanced budgets in the medium term, and governments must reduce deficits during economic upturns as a cushion against recession, he added. But, under the new blueprint, countries with low levels of long-term debt, such as the UK and Ireland, will be allowed to increase investment spending by running bigger short-term budget deficits. This concession is likely to apply to those whose debt is less than 40 per cent of GDP.

More leeway to borrow for investment in public services has been one of the main demands of the Chancellor, Gordon Brown. Although the UK is outside the 12-nation euro bloc, it has to sign up to the EU's economic policy guidelines.

Meanwhile, the Commission's plan would force highly indebted euro group members, such as Italy, Greece and Belgium, to make greater efforts to reduce their debt, making them liable to disciplinary action – and ultimately fines – if they fail to do so. EU officials said they hoped the changes would be given political backing by EU governments over the next three months.

The European Commission president, Romano Prodi, who called the pact "stupid" last month, said yesterday: "We must learn from experience and implement the Stability and Growth Pact in a more intelligent way." He said that, in the long term, greater powers would be sought to discipline countries that overspend in good times and fail to curb their deficits in downturns.

A British official said the Government welcomed the move, which "looks to go some way towards the UK's prudent interpretation" of the pact.