Europe, under fire, seeks to get ahead of crisis (Reuters)

WASHINGTON (Reuters) – European policymakers showed signs they were preparing new steps to cope with the region's debt crisis even as talk of a possible Greek default gained pace on Friday.

World stock markets, which had plunged to a 14-month low on fears the euro zone crisis was not under control, steadied after European Central Bank officials said they would use their firepower to help the banking system through the crisis.

Finance ministers and central bankers from around the world, in Washington for semi-annual policy discussions, have turned up the heat on Europe to do more to prevent Greece's debt crisis from infecting the world economy.

"They have six weeks to resolve this crisis," said British finance minister George Osborne. Euro zone leaders needed to have the situation under control by the time leaders of the Group of 20 economies meet in France in November, he said.

Germany's Chancellor Angela Merkel told a meeting of her political party members that a Greek default was not an option for her because it might trigger a domino effect in other struggling economies.

"The damage would be impossible to predict," she warned.

Pressure is growing on European governments for a recapitalization of the region's vulnerable banks -- perhaps to strengthen them in preparation for a Greek default.

Policymakers in Europe also seemed to be warming to the idea of giving more firepower to their bailout fund.

"Europe is running against time," Brazilian Financial Minister Guido Mantega said. "I hope Europe does not wait for the first countries to break before putting new instruments in place because then the bill will be higher."

In a statement on Thursday, leaders from seven big economies underlined the gravity of the situation now facing Europe after months in which it had seemed unsure of how to tame a crisis that threatens to spread from one economy to the next.

"The barriers to action are now political as much as economic," they said. "We must send a clear signal that we are ready to take the actions necessary to maintain growth and stability for all for the future."

Politicians in northern Europe, especially in Germany, have opposed dedicating more money to fight a crisis that they see as caused by the profligacy of countries such as Greece.

The head of the International Monetary Fund, Christine Lagarde, said Europe and the grim economic outlook in the United States required a new collective effort or "we run the risk of losing the battle for growth."

PUZZLE PIECES

As European policymakers looked to piece together a bolder crisis-fighting strategy, the ECB provided some relief to investors as three officials said banks could be primed with one-year liquidity to help shore them up.

"During the time of the (2007-2009) financial crisis, one of the instruments we had was ... one-year tenders. I think it might be advisable to think about reintroducing this approach," ECB governing council member Ewald Nowotny said.

The IMF, which has been pressing aggressively for a recapitalization of Europe's banks, reckons the debt crisis has increased their risk exposure by 300 billion euros.

In a sign Europe was coming to terms with the idea of a recapitalization, France's top market regulator said 15 to 20 banks needed extra capital, although no French ones "at this stage."

The prospect of a Greek default appeared to grow when Finance Minister Evangelos Venizelos was quoted by two newspapers as saying an orderly default with a 50 percent haircut for bondholders was one way the heavily indebted euro zone nation's cash crunch could be resolved.

Officials played down the reports and Venizelos described them as an unhelpful distraction from the central task of sticking to Greece's EU/IMF bailout program.

ECB governing council member Klaas Knot told a Dutch daily a Greek default could no longer be ruled out, the first ECB policymaker to speak openly of the prospect.

"It is one of the scenarios," Dutch daily Het Financieele Dagblad quoted him as saying. "All efforts are aimed at preventing this, but I am now less certain in excluding a bankruptcy than I was a few months ago."

MARKET HOPES

Hopes the ECB would take further steps to ease the stress of the region's banks, some of which hold a large amount of souring sovereign debt, fueled a late rally in European shares, although U.S. stocks were mixed in afternoon trade.

G20 finance ministers and central bankers had pledged on Thursday to "take all necessary actions to preserve the stability of the banking system and financial markets as required," a statement that failed to placate investors.

The G20 statement, issued after talks in Washington, said the 17-nation euro zone would implement actions to "maximize" the impact of the region's bailout fund by mid-October.

G20 participants did not say how the 440 billion-euro European Financial Stability Facility might be altered although French Finance Minister Francois Baroin used the word "leverage' in comments to reporters.

The United States has called on Europe to leverage up the EFSF to give it more firepower.

Antonio Borges, head of the IMF's European department, told a news conference that euro zone members need to quickly approve changes to the fund that they agreed to in July to make it more flexible. But he said it was too early to talk about leveraging the fund's resources.

The IMF's Lagarde said it might be wise for the ECB to continue buying government bonds even after Europe's bailout fund is given the power to do so. Tensions have flared within the ECB over its decision to buy bonds of struggling states.

(Additional reporting by IMF reporting team in Washington, Sakari Suoninen in Frankfurt, Natsuko Waki and Ana Nicolai da Costa in London, Lefteris Papadimas and Ingrid Melander in Athens; Writing by Glenn Somerville, William Schomberg and Paul Taylor; Editing by Neil Stempleman)

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