Responding to pleas from Spanish and Italian leaders, a midnight summit of the 17-nation currency area agreed that euro area rescue funds could be used to stabilise bond markets without forcing countries that comply with EU budget rules to adopt extra austerity measures or economic reforms.
After hours of argument, they also agreed that the blocs future permanent bailout fund, the European Stability Mechanism, would be able to lend directly to recaptalise banks without increasing a countrys budget deficit, and without preferential seniority status.
The process was tough, the outcome was good, Italian Prime Minister Mario Monti said, adding that Italy did not intend at this time to apply for the emergency support.
Countries that requested bond support from the rescue fund would have to sign a memorandum of understanding setting out their existing policy commitments and agreeing a timetable. But they would not face the intrusive oversight of a troika of international lenders to which Greece, Ireland and Portugal have been subjected, Monti said.
Spain and Italy had earlier withheld their agreement to a growth package at a European Union summit to demand emergency action to bring down their spiralling borrowing costs.
European Council chairman Herman Van Rompuy said the aim was to create a supervisory mechanism for euro zone banks involving the ECB to break the vicious circle of dependence between banks and sovereign governments.
We are opening the possibility to countries that are well behaving to make use of financial stability instruments in order to reassure markets and to get again some stability around some of the sovereign bonds of our member states, Van Rompuy said.
The euro surged by 1.1% to $1.2581 after the euro zone affirmed its commitment to use its bailout funds more flexibly and efficiently to stabilise markets.
But whether investors regard the deal struck at the 20th summit since the crisis erupted in early 2010 as sufficient remains to be seen. Previous relief rallies have fizzled within days or hours as new doubts set in.
Monti and his Spanish counterpart, Mariano Rajoy, had refused to sign off on a 120-billion-euro growth package until EU paymaster Germany approved short-term measures to ease their cost of credit. The clash highlighted tensions between northern creditor countries and heavily indebted southern states over the future shape of the troubled 17-nation bloc.
German Chancellor Angela Merkel, leader of Europes biggest economy, said she was satisfied with the result although she had dismissed any need for emergency support for Italian and Spanish bonds earlier this week.
We made a good decision today, in particular concerning growth and combatting unemployment and also on future measures for the EFSF and ESM. We will continue to work on long-term measures. I believe that we will reach a good conclusion tomorrow, she said.
Euro zone leaders will return on Friday to discuss longer-term plans to build a much closer fiscal and banking union, on which they asked Van Rompuy and the heads of the European Commission, ECB and Eurogroup finance ministers to present detailed proposals by October.