* Ministers reach deal on ESM, no Irish debt relief
European central bankers have signalled they stand ready to raise interest rates next month despite uncertainty linked to Japan's nuclear crisis and the ongoing struggles of euro members Greece, Ireland and Portugal.
Euro zone finance ministers meeting in Brussels this week sealed an agreement on funding of a new safety net for the bloc, but left it to a summit of EU leaders later in the week to work out a deal with Ireland on debt relief and forge a compromise on boosting an existing rescue facility.
Meanwhile, Portugal's government warned that it could step down even before that summit takes place if opposition parties block new spending cuts in a parliamentary vote expected on Wednesday.
That would ratchet up pressure on the country to follow in the footsteps of Greece and Ireland and seek a bailout from the EU and IMF.
Investors appear increasingly confident that the bloc can prevent its sovereign debt woes from spreading beyond Portugal, given progress on a package of anti-crisis measures that leaders are expected to sign off on by Friday.
The risk premium markets demand to hold Spanish 10-year debt, for example, has fallen to its lowest level since early February, and the euro pushed above $1.42 on Monday for the first time in over four months.
Rising inflation in core European countries like Germany has convinced the European Central Bank it is time to push up its benchmark rate, which has stood at a record-low 1.0% since May 2009.
ECB President Jean-Claude Trichet shocked markets in early March by saying the bank could raise rates as early as April and he made clear on Monday that this message was still valid even after Japan's devastating earthquake, tsunami and nuclear disaster.
"VERY HIGH VIGILANCE"
"Inflation in the euro area is on the rise," Trichet told the Economic and Monetary Affairs committee of the European Parliament.
Several of Trichet's ECB colleagues drove home the warning in even stronger language. Luxembourg's central bank chief Yves Mersch used the term "very high vigilance" to describe the bank's approach and Italy's Mario Draghi said policymakers stood ready to act in a "firm and timely way".
Higher rates could make it more difficult for the economies of Greece, Ireland and Spain to recover as all have a high percentage of floating rate mortgages, fragile banking sectors and major budget consolidation programmes in place.
The hawkish talk from ECB officials came as European finance ministers met in Brussels to hammer out the final details of a deal that is expected to be approved by EU at a two-day summit in Brussels that starts on Thursday.
"I can tell you we have an agreement on all elements relating to the ESM and I am delighted that that's the case," Jean-Claude Juncker, head of the Eurogroup forum of euro zone finance ministers, told a news conference, referring to the European Stability Mechanism.
He said the 500 billion euro rescue facility, which will take the place of the bloc's current EFSF fund from mid-2013, would be backed up by a combination of capital and guarantees totalling 700 bln euros.
Unlike the European Financial Stability Facility (EFSF), the ESM will be able to buy the bonds of euro members in the primary market but only in exceptional circumstances. It also sets the stage for private bond holders to share the pain in the event member states require debt relief.
The meeting failed to reach a compromise with Finland on boosting the EFSF to its full capacity of 440 bln euros, an issue which is likely to be taken up by the leaders.
IRELAND AND PORTUGAL
They will also examine better loan terms for Ireland, which was forced into an 85 bln euro EU/IMF rescue late last year, largely because of huge losses at its banks.
Germany, France and other euro zone members want Dublin to sign up to an agreement on harmonising corporate tax base rules before reducing the interest rates Dublin pays on its EU aid.
"Today we decided nothing on Ireland because we had no indication from our Irish colleague of any kind of modification," French Economy Minister Christine Lagarde said.
Earlier, EU sources told Reuters that the 35 bln euros set aside for Ireland's troubled banks might not be enough to cover losses at institutions whose rampant property lending during the "Celtic Tiger" years boomeranged when the global financial crisis hit.
The other big worry is Portugal, where opposition parties are threatening to block the minority Socialist government's latest round of austerity measures — a move that could topple Prime Minister Jose Socrates and accelerate a bailout.
A vote in parliament is expected on Wednesday, a day before the EU summit.
