Italy needs some kind of bailout and France and Germany discuss a smaller and more integrated euro zone

Telegraph UK – Italy’s escalating crisis prompted questions about whether European leaders had sufficient will or financial firepower to rescue it.

Angela Merkel, the German chancellor, called for deeper European integration and a new “breakthrough” treaty that would give the EU greater fiscal powers to stop member states from slipping into dangerous levels of debt.

There were also reports that German and French officials were privately looking at ways to make it possible for European nations to leave the eurozone, causing US shares to slump by three per cent last night.

The turmoil dramatically increased the risk of a “double dip” recession in Britain, with most economists predicting that the economy will grind to a halt before the end of the year.

A full-scale Italian financial collapse could knock “several percentage points” off the size of the British economy. British banks have more than £42 billion of outstanding loans to Italy, including almost £10 billion to the government.

Eurozone leaders were accused of failing to get on top of the crisis. Last month, they announced plans for a one-trillion-euro bail-out fund but have struggled to raise money for the scheme.

Reuters – German and French officials have discussed plans for a radical overhaul of the European Union that would involve setting up a more integrated and potentially smaller euro zone

French President Nicolas Sarkozy gave some flavor of his thinking during an address to students in the eastern French city of Strasbourg on Tuesday, when he said a two-speed Europe — the euro zone moving ahead more rapidly than all 27 countries in the EU — was the only model for the future.

The discussions among senior policymakers in Paris, Berlin and Brussels raised the possibility of one or more countries leaving the euro zone while the remaining core pushes on toward deeper economic integration, including on tax and fiscal policy.

British Prime Minister David Cameron urged European leaders to “urgently” finalise the plans over how a one-trillion euro fund to rescue beleaguered countries would be funded and operated.

“You need to have in place the biggest possible firewall”, he said. “That is what the EFSF [European Financial Stability Facility] is all about and the eurozone urgently needs to put flesh on the bones on the size of that firewall to stop this contagion going any further.”

The Italian president, Giorgio Napolitano, announced that austerity plans would be agreed “within days”, paving the way for Mr Berlusconi’s departure and a new government to be installed next week.

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