Merkel and Sarkozy agree plans to shore up Euro

Hopes of an enduring solution to the eurozone crisis soared yesterday as France and Germany proposed a new treaty to impose budgetary discipline and restore confidence in the euro.

President Nicolas Sarkozy and Chancellor Angela Merkel will ask other EU leaders later this week to approve sweeping ideas for a new, or amended, EU treaty to punish countries that allow their deficits to spin out of control.

Although falling short of the federalist "fiscal union" that Germany had demanded, the plans would impose near-automatic penalties on countries that broke agreed budget and debt limits. All euro members would be expected to introduce a "golden rule", enshrining the principle of balanced budgets in their constitutions.

The plan is closer to the kind of inter-governmental agreement demanded by Mr Sarkozy than to the stricter, euro-federalist proposals put forward by Ms Merkel. But the ideas do follow German doctrine in rejecting the concept of eurobonds, or state debt underwritten by the eurozone.

An unspoken understanding exists that the European Central Bank will extend its short-term help to heavily indebted nations once the new rules are approved.

Ms Merkel and Mr Sarkozy, speaking after talks in Paris, said they hoped their ideas would win broad approval from other EU leaders at a summit in Brussels on Thursday and Friday and that the details of a new or amended treaty could be finalised by March.

The first reaction of bond and stock markets was enthusiastic. And there was a further fillip for the eurozone last night when the International Monetary Fund approved the latest – €2.2bn (£1.9bn) – tranche of loans to Greece.

Despite the broad agreement yesterday, the French and German leaders left open the crucial question of how their ideas would be framed in treaty form. Should there be a new treaty, or amendments to the existing treaty, or a protocol?

Mr Sarkozy and Ms Merkel said that they would ideally like all 27 EU countries to sign up but would settle for a "second-best" agreement by the 17 euroland countries alone. This appeared to leave an escape route for David Cameron, who is resisting Eurosceptic pressure for concessions to the UK in other areas if the existing EU treaty is redrawn.

This week's summit is widely seen as the last chance for European leaders to stop the euro from capsizing and the West returning to recession.