Ireland's new leader Enda Kenny faces a daunting task as he tries to change the terms of his country's €67bn (£57bn) EU-IMF package, either by cutting the penal rate of interest or changing the remit of the rescue fund to help Ireland claw its way out of a debt trap.
The three parties in Chancellor Angela Merkel's coalition have issued a paper ruling out use of the bail-out machinery to purchase the bonds of eurozone states in trouble, or engineer a "soft" debt-restructuring by lending to these countries so that they can buy back their own debt cheaply from the market.
They oppose any form of eurobond that puts Germany on a slippery slope towards a 'Transferunion', and have demanded a Bundestag vote on the accord reached by Mrs Merkel at next week's EU summit.
A group of 189 German professors has stiffened the Bundestag further by warning of "fatal consequences for the whole process of European integration" if the EU crosses the Rubicon to a de facto debt union.
"I cannot remember any occasion when lawmakers have set guidance like this before: Merkel has very little leeway," said Hans Redeker, currency chief at BNP Paribas. "There is going to be disappointment at the summit and that will make life even harder for the EMU periphery."
Mr Redeker said the EU's new criteria for bank stress tests to be agreed this week adds another risk. If the tests are seen as a sham, like last time, they will sap confidence: If too tough, they will revive fears over the capital levels of weaker lenders.
The EU dispute comes as the latest oil spike queers the pitch for vulnerable countries on Europe's fringes. A report by Ernst & Young warns that if oil stays near $120 for the rest of this year, it will cut EMU growth to just 1.1pc this year and 1.2 next.
"We think the peripheral countries would suffer most. Spain, Greece, and Portugal face a double whammy since they have no room to offset the oil shock by slowing the pace of fiscal consolidation," said the author, Marie Diron. Oil at $150 would tip the eurozone back into recession, with the risk of cross-border bank contagion and default by at least one country.
German finance minister Wolfgang Schauble is hoping for a "grand bargain" in which weaker EMU states agree to stringent discipline in exchange for a boost to the bail-out fund, hoping this will assuage critics at home.
However, Germany's plans for budget vetting and intrusive reforms set off a storm at an EU leaders dinner earlier this month, with some calling it a diktat that trampled on sovereign prerogatives. Mr Schauble has dug in his heels, insisting that "the German government is not willing to make any compromise on this issue."
The European Commission has sought to defuse the crisis by drafting its own compromise plan, but any dilution will inflame critics in Germany. Bundesbank chief Axel Weber has already attacked the EU proposals for a more 'pro-active' rescue fund as a move to eurobonds "through the back door", shifting debt costs onto EU taxpayers.
If anything, hard-liners are gaining strength in Germany, Holland, and Finland, where the eurosceptic True Finn party is surging in polls. All three states oppose a cut in the penal rate on bail-out packages, fearing moral hazard and the risk that others will be tempted to tap the fund.
Ireland is paying 5.9pc on the EU chunk of its loans, far above the EU funding cost of 2.6pc. Jens Larsen, Europe strategist at RBC and a former IMF director, said the policy makes no sense.
"This shouldn't be a mechanism to punish countries, but to help them turn around the ship. I think a 4pc rate would be reasonable. But what matters most is giving the European Financial Stability Facility a wider remit so that it can intervene in secondary bond markets. If there is no deal, we could see renewed contagion," he said.
Andreas Rees, Unicredit's Europe economist, said Ireland should have "no problem" paying 5.9pc. This rate lifts Irish debt service costs to 4pc of GDP, compared to 10pc in the 1980s.
Mr Kenny's problem is that this hawkish view reflects broad German opinion. His other problem is what happens as recovery pushes up bond yields across the board, lifting rates on Ireland's loan package pari passu.
His trump card is to threaten 'haircuts' on senior bank creditors if the EU refuses to compromise, a move that might set off EMU-wide contagion and inflict big losses on German Landesbanken. To play to such a card would enrage Europe, but not to play it might test patience of an aggrieved Irish nation.
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