Eurozone seals grand bargain to help Italy and Spain

Following tense talks that stretched into the early hours, EU president Herman Van Rompuy told reporters a "real breakthrough" had been struck to calm financial markets and reshape the eurozone to prevent the crisis recurring.

European Commission President Jose Manuel Barroso hailed a "very ambitious decision that shows once again the commitment of the member states ... to the irreversibility of the euro and I think this will be recognised by all."

Following the agreement interest rates on Spanish and Italian 10-year bonds dropped, while European stocks rose sharply at the start of trading Friday.

The Spanish reference rate fell to 6.466% from 6.896% on Thursday while the Italian rate fell to 5.865% from 6.182%.

London's benchmark FTSE 100 index rallied 1.74 percent, Frankfurt's DAX 30 jumped 2.39 percent and in Paris the CAC 40 spiked 2.86 percent.

Madrid rocketed 3.17 percent and Milan more than 3.0 percent.

The accord paves the way for the eurozone's 500-billion-euro ($630 billion) bailout fund to recapitalise ailing banks directly, without passing through national budgets and adding to struggling countries' debt mountains.

This however, would occur only after a Europe-wide banking supervisory body is set up, with leaders aiming for this to happen at the end of the year.

Another key measure agreed was that the bailout funds would be used "in a flexible and efficient manner in order to stabilise markets" -- a reference to buying countries' bonds to drive down high borrowing costs that have crippled Spain and Italy.

"We took a good decision on growth," said German Chancellor Angela Merkel as she left the meeting.

Merkel appeared to have dropped her insistence on recapitalisation funds to banks being channelled through governments but kept her demand that any such aid be combined with demands for reform of the financial sector.

EU leaders also agreed a package of measures worth some 120 billion euros they hope will bolster growth in the recession-hit bloc.

They pledged to boost the capital of the European Investment Bank by 10 billion euros that should boost its overall lending capacity by 60 billion and help vulnerable countries fund economic expansion to "grow themselves out of the crisis."

Another 55 billion euros is to be scraped together from unused EU funds and earmarked for small- and medium-sized enterprises and youth employment schemes, the EU chief said.

But in a shock about-turn, Italian Prime Minister Mario Monti and his Spanish counterpart Mariano Rajoy had threatened to block a wider "growth pact" unless they won concession on short-term moves to drag their economies from the mire.

This prompted one European diplomat to fume that Madrid and Rome were "holding the pact hostage."

The head of the eurogroup finance ministers, Luxembourg Prime Minister Jean-Claude Juncker, said that Italy and Spain dropped their resistance in return for the short-term measures to stabilise their economies.

A beaming Monti told reporters afterwards: "Everything is very important for the future of the EU and the eurozone. Italy is doubly satisfied."

He acknowledged there were "some tensions" and said that he had to "put quite a bit of pressure" on other leaders to force through his wishes.

The summit, which continues later on Friday, was being scrutinised both by jittery financial markets and world leaders, as the eurozone battles to solve its two and a half year debt crisis that has endangered the global economy.

Stocks in Asia reversed earlier losses as news of the deal hit trading floors and the euro also rose sharply as analysts reassessed their low expectations from the meeting.

Shares in Tokyo jumped sharply, with the Nikkei 225 bouncing 1.44 percent in early afternoon trade.

In a longer-term perspective, EU leaders also agreed on a tentative "roadmap" for the future shape of the eurozone that could include a banking union and a budgetary union, Van Rompuy said.

He said he would produce another report with a "specific and time-bound roadmap for the achievement of a genuine economic and monetary union" in October.

Leaders believe a revamped eurozone is essential to avoid a further crisis happening again.