European leaders have agreed on a permanent rescue fund to cover countries in need of financial assistance. German Chancellor Merkel hailed the summit as a success, but the measure has failed to reassure the markets.
Germany and France oppose introducing euro bonds.
European leaders meeting in Brussels have set up a permanent emergency fund to help debt-laden countries, and have agreed to rewrite some of the bloc's rules in a bid to shore up the value of the euro.
"We will do everything to secure the financial stability of the euro as a whole," German Chancellor Angela Merkel said at a news conference after a European Union summit.
She added that reform and stability will remain on the euro zone's agenda next year as the bloc fights to secure the single currency and make its economies more competitive.
But the move was given an emphatic thumbs-down as the ratings agency Moody's downgraded Ireland's credit rating on Friday by five notches, to Baa1, two notches above Junk.
"While a downgrade had been anticipated, the severity of the downgrade is surprising," Dublin-based Glas Securities said.
EU leaders have spent most of 2010 trying to come up with successful measures to stop the region's debt crisis spreading, but Greece and Ireland have already been forced to seek EU bailouts and Portugal, Spain, Belgium and others are now in the spotlight.
On Thursday leaders agreed on a change to the EU treaty to create the European Stability Mechanism (ESM) – a permanent financial safety net of 750 billion euro from 2013 - that will help countries with liquidity problems and allow for debt restructuring of insolvent ones.
Merkel is determined to stabilize the euro
EU leaders confirmed that private investors would be involved in the future euro zone rescue mechanism, a draft summit statement showed.
Merkel said the fund would be sufficiently large.
"The more coherent economic policies are, the more we see by 2013 that states have made progress with a culture of stability, the lower the financial extent of the (rescue fund) will have to be," she added.
Germany lobbied hard for changes to the Lisbon Treaty and a pledge to pay out aid only if it's "indispensable," as leaders meeting in Brussels on Thursday agreed on the need to make a temporary trillion dollar rescue fund into a permanent one.
But market concerns are focused on whether the euro zone has sufficient immediate funds to come to the aid of the likes of Portugal or Spain, should they need a bailout next year.
"The new ESM should safeguard the euro zone's financial stability in the future. However, it is to some extent window-dressing as it does not solve the current crisis," said Carsten Brzeski, senior economist at ING bank.
The euro zone's current fund - the European Financial Stability Facility (EFSF) - can borrow on the markets backed by euro zone government guarantees and has up to 440 billion euro to lend to governments cut off from market financing.
But many economists believe that even though only a small part of the EFSF's funds have been used to help Ireland, it may turn out to be insufficient if more countries need help.
"European leaders failed to address the issue of debt sustainability and possible insolvency problems prior to 2013. Debt restructuring, a common euro zone bond or an increase of the EFSF? None of these issues have been addressed. But they have to be," Brzeski said.
Markets reacted unvaforably to the EU summit
"The preliminary outcome of the EU summit represents yet another missed opportunity by European policymakers to forcefully address investor concerns and calm markets in a more sustainable and pre-emptive manner," said Frank Engels, economist at Barclays Capital.
Underlining the need to reassure financial markets over fears that Portugal and Spain may be in need of bailouts soon, the European Central Bank also announced on Thursday that it would double its capital to 10.76 billion euros ($14.3 billion) to cope with an increase in market volatility.
Bonds kept off agenda
Discussion about the introduction of "E-bonds," which would allow all European nations to borrow money at common rates, was kept off the agenda.
Merkel has said that the common bond plan "would not rid Europe of its weaknesses, it would simply transmit them across the board."
Germany is strongly opposed because E-bonds would effectively mean all 16 euro zone countries - or 17 when Estonia joins the currency from Jan. 1, 2011 - financing a portion of their debt together and sharing a credit rating.
Berlin, which is the benchmark issuer of debt in the euro zone and enjoys the lowest borrowing costs thanks to its economic strength and reliability, would have to surrender some of its credit to riskier euro states such as Greece and Ireland.
Although Germany is publicly opposed to the idea of euro-bonds, some in the euro zone back the idea.
"Germany's rejection of the expansion is another example of how euro zone governments do not agree on the best way forward to deal with this crisis," said BNP Paribas' Wattret.
"As a result, the measures taken have been piecemeal, unconvincing and reactive rather than pre-emptive. This is going to have to change if confidence is to be restored in a lastingway," he said.
Leaders were meeting in their seventh summit of a busy year, as markets have grown increasingly wary that EU states might default on loans secured through individual government bonds.
Author: Natalia Dannenberg (AP, AFP, dpa, Reuters)
Editor: Rob Turner