Europe secured an historic agreement to draft a new treaty for deeper economic integration in the euro zone on Friday, but Britain, the region's third largest economy, refused to join the other 26 countries in a fiscal union and was left isolated.
The outcome of a two-day European Union summit left financial markets uncertain whether and when more decisive action would be taken to stem a debt crisis that began in Greece in 2009, spread to Portugal, Ireland, Italy and Spain and now threatens France and even economic powerhouse Germany.
A new treaty could take three months to negotiate and may require loseable referendums in countries such as Ireland. While nine non-euro-zone countries said they would join the euro zone in backing it, there were quickly notes of caution from some corners, including the Czech Republic and Hungary.
Two ECB sources told Reuters the European Central Bank would keep purchases of euro zone government bonds capped for now and take no extra firefighting action. Debt markets were wary. Interbank lending rates eased but Italian 10-year bond yields rose to around 6.5%.
Under the new treaty plan, the leaders agreed to pursue a tougher budget discipline regime with automatic sanctions for deficit sinners in the single currency area, but Britain said it could not accept the proposed treaty amendments after failing to secure concessions for itself on financial regulation.
"This is a breakthrough to a union of stability," German Chancellor Angela Merkel said. "We will use the crisis as a chance for a new beginning."
After 10 hours of talks that ran into the early hours of Friday, Britain found itself without any allies around the table, diplomats said. All the other non-euro states said they wanted to take part in the fiscal union process, subject to parliamentary approval.
"Once Cameron said for sure he wasn't in, it only took minutes for the other 26 to agree that they would push ahead with an intergovernmental treaty," one senior official involved in the discussions told reporters.
The rift, which could widen into a permanent divide between London and the continental mainland, occurred 20 years to the day after European leaders agreed at the Maastricht summit to create the single currency, with Britain opting to stay out.
Prime Minister David Cameron insisted at a news conference that it remained in Britain's interest to stay in the EU and take advantage of its single market.
One senior EU diplomat called Cameron's negotiating tactics "clumsy". Among other things, he had sought a veto on a proposed financial transaction tax, which may now be voted through by a majority over the objections of London's financial centre.
NO BIG BAZOOKA
ECB President Mario Draghi called the EU's decision a step forward for the stricter budget rules he has said are necessary for the euro zone to emerge stronger from the turmoil.
"It's going to be the basis for a good fiscal compact and more discipline in economic policy in the euro area members," Draghi said. "We came to conclusions that will have to be fleshed out more in the coming days."
Two ECB sources said the bank's governing council decided on Thursday to keep bond buying limited to around 20 billion euros a week and there was no need to review the decision in the light of the summit outcome.
"You will see some further purchases but not the huge bazooka that some people in the markets and the media are awaiting," one central banker said.
French President Nicolas Sarkozy told reporters the ECB's move to provide unlimited three-year funds to cash-starved European banks would be more effective, by enabling them to continue buying government bonds.
"This means that each state can turn to its banks, which will have liquidity at their disposal," he said.
Analysts said the notion that commercial banks could step up their purchases of government bonds looked optimistic given the same banks are being asked to deleverage and recapitalise.
"SEETHES, SULKS, GLOATS"
Merkel said the world would see that Europe had learned from its mistakes and avoided "lousy compromise".
Sarkozy sounded elated at having united a big group around the euro zone as the EU's core, long a French objective, and many diplomats perceived France as being the big winner.
"This is a summit that will go down in history," he said. "We would have preferred a reform of the treaties among 27. That wasn't possible given the position of our British friends. And so it will be through an intergovernmental treaty of 17, but open to others."
One EU diplomat summed up the outcome as: "Britain seethes, Germany sulks, and France gloats."
Active ECB support will be vital in the coming days with markets doubting the strength of Europe's financial firewalls to protect vulnerable economies such as Italy and Spain, which have to roll over hundreds of billions of euros in debt next year.
Traders said the ECB bought Italian bonds on Friday to steady markets.
The euro rallied in Europe and U.S. shares gained, but analysts said the summit had done little to convince markets that a solution to the crisis was at hand.
LAST-CHANCE SALOON?
In a meeting billed by some as a last chance to save the euro, the leaders also took several decisions on the permanent bailout fund, the European Stability Mechanism, which will come into force a year early in July 2012.
The ESM's capacity will be capped at 500 billion euros ($666 billion), less than had been suggested was possible before the summit, and the facility will not get a banking licence, as Van Rompuy originally had proposed, due to German opposition.
It also was agreed that EU countries would provide up to 200 billion euros in bilateral loans to the IMF to help it tackle the crisis, with 150 billion euros of the total coming from the euro zone countries.
