Germany dampens hopes as France warns of euro 'explosion'

Piling the pressure on EU leaders due to meet in Brussels from Thursday, Standard and Poor's put a number of large European banks on review and placed the European Union on watch for a downgrade of its AAA credit rating.

German officials said reaching a deal would be "difficult" as US Treasury Secretary Timothy Geithner pressed Europe for decisive action to tackle the crisis and US President Barack Obama spoke to German Chancellor Angela Merkel.

"Europe is not out of the crisis. The risk of an explosion abounds as long as the decisions taken with Angela Merkel are not implemented," Sarkozy told lawmakers from his ruling UMP party, according to a participant in the meeting.

US stocks erased losses in the last hour of trade Wednesday to end mostly higher, but European stocks and the euro slid as pessimism set in.

On Monday, Sarkozy and the German chancellor announced comprehensive reform plans for the eurozone, having called for changes to the 27-member EU treaty to improve a eurozone framework generally seen as defective almost 10 years after the common currency was introduced.

Merkel and Sarkozy sent a letter to EU president Herman Van Rompuy on Wednesday to outline their plans for "reinforced governance" of the eurozone "to ensure budget discipline as well as stronger growth and increased competitiveness."

They proposed a "new, common legal framework" to boost financial and labour market regulation, the harmonisation of the corporate tax base and the imposition of a tax on financial transactions.

In London, Prime Minister David Cameron said in parliament Wednesday that if Britain is asked to back a new EU treaty to breathe new life into the euro, he intended to exact a high price in return.

"The more that countries in the eurozone ask for, the more we will ask for in return," he said.

Cameron also repeated his threat to veto any treaty change if Britain fails to receive "safeguards" from its European partners, particularly for the City of London financial services hub.

This week's summit, where leaders will consider ways to improve budget discipline and tighten economic union, is seen as crucial to efforts to stop the debt contagion threatening the eurozone and to salvage the embattled single currency.

A spokesman for Merkel, Steffen Seibert, told journalists: "We are expecting very challenging and occasionally very difficult talks."

Earlier, a German government source, who insisted on anonymity, poured cold water on hopes for a deal at the summit.

"Several partners have not yet understood the gravity of the situation" facing the EU, the source said.

Austria joined Germany Wednesday in playing down expectations, with Chancellor Werner Faymann telling lawmakers the summit "will not meet the goal of creating a comprehensive firewall for the eurozone for the next three to five years."

Amid international concern the crisis will weaken the global economy, Geithner said he had told European leaders "how important it is for the US and countries around the world that Europe succeed."

"I'm confident they will succeed," he said after talks in Paris with French Finance Minister Francois Baroin.

Baroin stressed that in Brussels, "neither Angela Merkel nor Nicolas Sarkozy will leave the table without a strong agreement being signed."

Obama meanwhile spoke to Merkel, with both emphasising the need for a "lasting and credible solution to the crisis," according to the White House.

The eurozone's top powerbrokers will meet in a restricted session ahead of the full summit on Thursday, an EU diplomat said.

At the meeting will be Merkel, Sarkozy, European Central Bank head Mario Draghi, Luxembourg Prime Minister Jean-Claude Juncker, who is the head of the eurozone finance ministers' body, Van Rompuy and European Commission chief Jose Manuel Barroso.

EU leaders are under intense pressure to convince markets they can come up with a rapid rescue plan for the eurozone following the threat of possible debt downgrades by Standard and Poor's.

S&P chief European economist Jean-Michel Six told France's Le Monde daily Wednesday the ratings agency "wanted to make a strong signal to emphasise the gravity of the crisis."

London's FTSE-100 index of top companies ended the day down 0.39 per cent, while in Paris the CAC-40 dipped 0.11 per cent and Frankfurt's DAX 30 dropped 0.57 per cent. Milan shed 1.24 per cent and Madrid 0.79 per cent.

The euro, which had earlier gained against the dollar, slid to $1.3391 from $1.3397 late in New York on Tuesday.

Despite the European malaise, US markets got a boost from a late report from the Federal Reserve showing consumer credit was growing at a 3.7 per cent annual rate in September, another sign that US consumers are spending, not hoarding, their dollars.