Europe could be in worst hour since WWII: Merkel (Reuters)

LEIPZIG, Germany (Reuters) – German Chancellor Angela Merkel said on Monday that Europe could be living through its toughest hour since World War Two as new leaders in Italy and Greece rushed to form governments and limit the damage from the euro zone debt crisis.

A rally on financial markets sparked by the appointment of respected European technocrats in Rome and Athens soon stalled. Analysts warned that daunting obstacles could hinder decisive action needed to breathe new life into their ailing economies.

Italy had to pay a euro-lifetime record yield of 6.3 percent to sell five-year bonds with investors wary of buying its debt until prime minister-designate Mario Monti can undertake profound economic reforms.

In a first sign of trouble for new Greek Prime Minister Lucas Papademos, the leader of the main conservative party rejected any toughening of austerity and refused to sign a letter sought by European authorities pledging support for a new 130 billion euro bailout.

Merkel dramatized the situation facing the euro zone in an attempt to rally her conservative party behind the government at a congress in Leipzig.

"Europe is in one of its toughest, perhaps the toughest hour since World War Two," she told her Christian Democrats (CDU), saying she feared Europe would fail if the euro failed and vowing to do anything to stop this from happening.

In a one-hour address, Merkel called for closer European political union but offered no new ideas for resolving the crisis that has forced bailouts of Greece, Ireland and Portugal, raising fears about the survival of the 17-state currency zone.

European Union governments have until a summit on December 9 to come up with the outlines of a much bolder and more convincing strategy, with some form of massive, visible financial backing.

Prospects are uncertain as the German government, the Bundesbank and hardliners in the European Central Bank have blocked key policy options. These include issuing common euro zone bonds, mutualising the euro zone's debt stock, letting the ECB create money to fight the crisis, or act as a lender of last resort, directly or via the euro zone rescue fund.

HIGH DRAMA IN ROME

In weekend drama, Italy's president asked Monti, a former European commissioner, to form a government to reverse a disastrous collapse of market confidence in an economy whose debt burden is too big for the euro bloc to bail out.

Italians sang, danced and drank champagne in the streets to celebrate the resignation of scandal-plagued billionaire Silvio Berlusconi, and an impromptu orchestra near the presidential palace played the Hallelujah chorus from Handel's Messiah.

The ECB has been buying troubled euro zone governments' bonds episodically to try to stabilize markets. But figures released on Monday showed it halved its weekly bond buy at the height of the Italian government crisis last week, suggesting it was no longer willing to help Berlusconi.

After a tumultuous week, when Italy's borrowing costs rose to the kind of levels that saw Ireland and Greece forced to seek international bailouts, initial market reaction was positive on Monday, with both stocks and bond markets lifted.

But in a sign of the fragile state of confidence, the trend was reversed after the Italian bond auction, and the release of figures showing industrial production slumped by 2 percent in the euro zone in September, raising the specter of recession.

"(Monti) is perceived to be a positive change for the country," said Annalisa Piazza, rate strategist at Newedge.

"Cautiousness on the future developments in Italy is fully justified. Credibility has been lost and it will take a while for market participants to believe that the country is back on the right track."

Monti held talks with political parties on Monday before separate meetings with trade unions and employers on Tuesday, as he moves to appoint what is expected to be a relatively small cabinet made up of experts from outside parliament.

He went to work after a frenetic weekend in which Italy's parliament approved a package of economic reforms agreed with European leaders, clearing the way for Berlusconi to resign.

"Monti spoke about a significant program with many sacrifices," Francesco Nucara, a lawmaker from one of the myriad tiny parliamentary groups involved in the talks, said after meeting the prime minister designate.

"IT DOESN'T END HERE"

But some were skeptical about the strategy to reverse the collapse of market confidence in Italy.

"It doesn't end here" read a headline in Libero, a fiercely pro-Berlusconi daily which said that "the Left and its newspapers may have uncorked the champagne too early".

While Italy's problems and the long-drawn-out departure of Berlusconi have pushed the collapse of the much smaller Greek economy backstage, IMF and European leaders will keep Papademos under pressure to implement radical reforms.

Papademos succeeded George Papandreou, whose proposal to hold a referendum on the bailout terms prompted EU leaders to raise the threat of a Greek exit from the currency bloc.

The new premier, who oversaw Greece's entry to the euro zone in 2002, must win a confidence vote on Wednesday before meeting euro zone finance ministers in Brussels on Thursday.

The Herculean task facing Papademos was illustrated on Monday when New Democracy leader Antonis Samaras said he would not vote for new austerity measures, adding that the policy mix of spending cuts and tax rises agreed with international lenders should be changed in favor of economic growth.

"I agree with the goals to cut government spending ... to reduce debt, to erase the deficit, to make structural changes. I do not agree with whatever stunts growth," he told party MPs.

Inspectors for Greece's international lenders, known as the troika, were due to meet the new administration of Papademos following Wednesday's confidence ballot but uncertainty surfaced over whether they would indeed come.

DISRUPTIVE DEMONSTRATIONS

Most Greeks hailed Papademos's appointment, but thousands of people angry at more than a year of austerity are expected to rally on Thursday, the anniversary of a 1973 student uprising that helped to bring down a 1967-1974 military junta.

That could complicate talks between the troika and the new cabinet, as the demonstration is expected to shut down central Athens and could be the biggest rally in months of protests that have at times erupted into bloody clashes.

"They may come at the end of the week but nothing is fixed," Carlos Martin Ruiz de Gordejuela, spokesman for the European Commission's mission in Greece, said of the troika team, which had been expected to arrive early in the week.

Monday's euro zone industrial production figures pointed to a sharp contraction toward the end of the year and the risk of a double-dip recession.

The slide in output at factories in the 17 nations sharing the single currency was the biggest fall since February 2009 -- when the economy was reeling from the worst financial crisis since the 1930s.

"It clearly doesn't bode well for the future," said Francois Cabau, an economist at Barclays Capital. "If we don't see some resolution of the euro zone sovereign debt crisis, business confidence could go even lower."

(Additional reporting by Philip Pullella and James Mackenzie in Rome, Ben Harding and Harry Papachristou in Athens, Eva Kuehnen in Frankfurt, Alexandra Hudson in Berlin and Robin Emmott in Brussels, writing by Peter Millership; Editing by Paul Taylor)

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Bernanke: Cutting too much too soon could hurt U.S. (Reuters)

By Mark Felsenthal and Pedro Nicolaci da Costa Mark Felsenthal And Pedro Nicolaci Da Costa – 26?mins?ago

WASHINGTON (Reuters) – U.S. Federal Reserve Chairman Ben Bernanke warned Congress on Thursday that overzealous cuts to government spending in the short term could derail an already fragile recovery and said a U.S. debt default may wreak financial havoc.

"I only ask ... as Congress looks at the timing and composition of its changes to the budget, that it does take into account that in the very near term the recovery is still rather fragile, and that sharp and excessive cuts in the very short term would be potentially damaging to that recovery," Bernanke told members of the Senate Banking Committee.

Congress and the White House are stalemated in talks on cutting the budget deficit, with Republicans seeking $2.4 trillion in spending cuts in exchange for agreeing to raise the $14.3 U.S. government borrowing limit. The U.S. Treasury has said it will run out of money after August 2 to pay all of the country's bills if the a deal is not reached to raise the debt ceiling.

On the second day of delivering the Fed's semiannual monetary policy report to Congress, Bernanke renewed his warning that a United States debt default would be devastating for the U.S. and global economies.

"It would be a calamitous outcome," Bernanke said. "It would create a very severe financial shock that would have effects not only on the U.S. economy, but the global economy."

Failure to raise the debt limit in time would constitute a "self-inflicted wound" to the economy, he added.

NEW DOWNGRADE THREATS

Moody's Investors Service warned late on Wednesday that the U.S. could lose its top credit rating in coming weeks if a standoff between the White House and congressional Republicans over raising the statutory borrowing limit is not resolved.

Earlier on Thursday, China -- the United States' biggest foreign creditor -- urged the U.S. government to adopt responsible policies to protect investors' interests after the Moody's warning.

Another ratings agency, Standard & Poor's, also privately told U.S. lawmakers and business groups that it might still cut the U.S.'s rating if the government fails to make any of its expected payments -- on debt or other obligations -- a congressional aide said on Thursday.

In comments that mirrored his remarks on Wednesday, Bernanke repeated that the Fed is prepared to act if the modest recovery from the recession that ended two years ago falters.

He also made clear, however, the Fed is not at that point now. For one thing, inflation is higher than in late 2010, when the Fed readied its most recent round of bond buying, he told lawmakers in response to questions.

"Today the situation is more complex," Bernanke said. "We're not prepared at this point to take further action."

On Wall Street, stocks fell as Bernanke's comments raised questions about the Fed's readiness to ease rates further. The dollar rose against most major currencies as another round of monetary stimulus looked remote.

Economic reports released on Thursday suggested the economy will struggle to regain speed in the second half of the year, as the Fed has forecast. The number of Americans claiming initial unemployment benefits dropped last week, but remained elevated and retail sales barely rose in June, government data showed.

Also last month's producer prices posted their steepest decline since February 2010 as energy prices eased.

While Fed policymakers have been worried about rising inflation, the risk of a damaging deflationary spiral could force the central bank to act to promote growth.

Economists polled by Reuters cut their outlook for U.S. growth to 2.5 percent this year. That forecast put the United States ahead of major European economies except Germany, but behind some major emerging markets including China.

Although Bernanke told Congress said the Fed's $600 billion bond buying program has been effective in lowering long-term interest rates and coaxing investors to take greater risks, it has been controversial, and several lawmakers questioned it on Thursday.

"I believe the stage is set for a resurgence of inflation if the Fed is not careful," Senator Richard Shelby told Bernanke at the hearing.

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Obama: seniors could be hurt without debt deal (Reuters)

WASHINGTON (Reuters) – President Barack Obama raised the stakes in the third straight day of budget talks on Tuesday by warning that senior citizens and veterans may suffer first if the debt ceiling is not raised by August 2.

The comments came as top Republicans toughened their stance in the deficit reduction talks. Senate Republican leader Mitch McConnell said a "real solution" to the U.S. debt problem was unlikely while Obama was in office.

U.S. business leaders pressed Obama and congressional leaders to act swiftly to raise the $14.3 trillion U.S. debt ceiling -- which caps how much the United States can borrow -- or risk derailing a sputtering economic recovery and endangering the global financial system.

Obama and top lawmakers from both parties were due to meet at the White House at 3:45 p.m. ET.

The president said in an interview with U.S. television network CBS that checks to recipients of the Social Security retirement program may not go out in early August if he and congressional leaders do not agree on a debt deal.

"I cannot guarantee that those checks go out on August 3rd if we haven't resolved this issue," Obama said, according to excerpts of the interview released in advance of its broadcast.

"Because there may simply not be the money in the coffers to do it," Obama said. He said veterans checks and disability benefits could also be affected without a deal.

After months of talks, Republican and Democratic leaders are still at an impasse over a deficit reduction deal that would clear the way for Congress to raise the debt ceiling.

While they agree on the need to raise the debt limit before the United States defaults on August 2, both sides have engaged in a furious blame game over the failure to advance the deficit reduction package.

Republicans on Tuesday ratcheted up pressure on Obama and his fellow Democrats, who have accused Republicans of refusing to compromise.

"I have little question that as long as this president is in the Oval Office a real solution is probably unattainable," McConnell said.

But he said Republicans will "do the responsible thing" and make sure the government does not default on its obligations on August 2, when the Treasury Department has warned it will run out of money to pay the country's bills.

White House spokesman Jay Carney called McConnell's comments "unfortunate."

UNCERTAINTY SEEPING INTO MARKETS

Failure to seal a deal by August 2 could spook investors, causing U.S. interest rates to surge and stock prices to plummet, and could put the United States at risk of another recession, Treasury officials and private economists have warned.

Republicans have balked at raising the debt limit without steep spending cuts, while Democrats also want to increase revenue by eliminating tax breaks for the wealthy and corporations in some sectors such as the oil and gas industry.

Republicans oppose any tax increases, which they argue would hurt the anemic economic recovery.

After briefing Republican members of the House of Representatives on the debt talks, House Speaker John Boehner said he was optimistic a deal could be reached. But he called the debt limit increase Obama's problem, a statement that drew immediate criticism from Democrats.

Despite the heated rhetoric, investors assume that Washington will ultimately avert a crisis. Yields fell to seven-month lows on the benchmark 10 year Treasury bond on Tuesday morning, fueled by debt worries in Europe.

But the impasse has investors' attention, and as the clock ticks toward August 2 with no deal in sight, it is contributing to a broadly negative sentiment on Wall Street.

Treasury Secretary Timothy Geithner, who has warned of catastrophic consequences if Congress fails to raise the debt ceiling, held firm on Tuesday to vows that the United States would not default. "Failure is not an option," he said.

Business leaders showed their growing concern by sending Obama and congressional leaders a letter on Tuesday that warned of the consequences if lawmakers did not reach a deal.

(Additional reporting by Andy Sullivan, Thomas Ferraro, Donna Smith, David Morgan, David Lawder, Laura MacInnis and Matt Spetalnick; Writing by Deborah Charles; Editing by Ross Colvin and Vicki Allen)

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