18 January 2011 Last updated at 11:15 ET

Euro up despite no sign of rescue fund deal

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The euro has risen sharply, despite signs that governments are in no rush to increase the eurozone rescue fund.

The single currency gained more than a cent against the dollar on Tuesday to about $1.34.

Meanwhile, an agreement is emerging over the terms of a much tougher round of stress tests for European banks, to be conducted later this year.

European finance ministers are discussing the tests on the second day of a two-day meeting in Brussels.

Comprehensive package

The European Financial Stability Facility (EFSF) was set up in May last year, and benefits from eurozone government guarantees for 440bn euros (£368bn; $590bn).

But in order to maintain its maximum triple-A-rating, the fund is effectively limited to borrowing about just 250bn euros, which many investors fear may prove insufficient to fund any future bail-out of Spain.

On Monday, German finance minister Wolfgang Schaeuble downplayed the need to urgently upsize the EFSF, sending the euro lower against most currencies.

However, he later accepted that his government may have to raise its guarantee for the fund at least enough for it to be able to lend the originally-intended amount.

The euro has since pushed higher again as speculation grows that an agreement will eventually be reached.

The pound remained steady at about 1.194 euros, as higher-than-expected UK inflation data raised the probability of an interest rate rise, boosting sterling.

Mr Schaeuble said he wants the eurozone to do more than just bolster its crisis response fund, in order to "absolve us from the necessity to react again every couple of months".

He has called for a comprehensive package of policies, including improvements in competitiveness and greater fiscal co-ordination, and does not expect agreement to be reached until late March.

'Broad' discussion

Jean-Claude Juncker, who is chairing the ministerial meeting, said that many options for bolstering the crisis response mechanism had been discussed, but none was favoured.

"All of the ingredients of the solutions we have to form are on the table," he said. "The discussion was broad and will be narrowed in the next couple of weeks."

Mr Juncker said ministers discussed the option of lowering the interest rate charged on bail-out loans.

The Irish Republic had to pay an average interest rate of 5.8% on its rescue loans, after Germany pushed for a penalty rate to ensure that governments only seek a bail-out as a last resort.

But markets fear that the high cost of borrowing will make it even harder for rescued governments to repay debts to private-sector lenders.

Lack of urgency

Both the European Commission and the European Central Bank (ECB) have called for an increase in the size of the EFSF, as well as giving it new powers, such as the right to buy up eurozone government debt.

In recent weeks, markets have been reassured by the ECB's decision to step up its own purchases of eurozone government debts.

Last week, the ECB seemingly confirmed its role in propping up the more financially stressed governments, by buying an unusually high 2.3bn euros in government debts ahead of key bond auctions in Portugal and Spain, both of which were successful.

However, there are concerns at the ECB that by entangling itself in governments' finances, it is undermining its independence.

Government debt problems have not gone away, as illustrated on Tuesday when the Greek government contradicted comments by its deputy prime minister suggesting the country would seek to extend the repayment dates on all of its debts in order to be able to repay them in full.

But by putting a floor under bond prices, the ECB has also reduced the sense of urgency among policy-makers, particularly in Germany, which has sought to resist rushed decisions.

"Market developments in the last week have, thank God, taken the urgency out of these discussions," commented Mr Schaeuble going into the talks.

Stress tests

Meanwhile, it emerged that ministers have agreed terms of a new round of stress tests for European banks.

Increasing the financial strength of Europe's banks is widely seen as a necessary step in solving Europe's government debt problems.

The new round of European tests will take place this May, with results to be published in the summer.

In contrast to the previous tests, the new ones are expected to include:

• a new "liquidity" test, required by the ECB, to ensure the banks have enough readily-available cash to survive - at least for some weeks - a run by depositors and lenders
• a cut in the value of government bonds that are held by banks on a long-term basis
• greater consistency in how they are implemented in different countries, including how the bank's core capital - which absorbs losses on its investments - is calculated.

European internal markets commissioner Michel Barnier has been taking advice from his counterparts in Washington, after similar stress tests on US banks were seen as stricter, and were much more successful in restoring market confidence.

In a previous round of European tests last year, only seven of the 91 banks examined failed. Allied Irish Banks passed the test, but had to be rescued later in the year.

In contrast, the US examined 19 banks in April, of which 10 were failed and forced to raise $75bn in additional capital.