The European Central Bank (ECB) has expressed "serious concern" at changes to the Stability and Growth Pact agreed by finance ministers on Sunday and due to be approved by EU leaders at a summit in Brussels today.
In a statement issued in Frankfurt, the ECB'S governing council signalled clearly that it would not hesitate to increase interest rates if the new rules lead to a lack of budget discipline that pushes up inflation.
"The governing council of the ECB is seriously concerned about the proposed changes to the Stability and Growth Pact," the statement said.
"It must be avoided that changes in the corrective arm undermine confidence in the fiscal framework of the European Union and the sustainability of public finances in the euro area member states... The public and the markets can trust that the governing council remains firmly committed to deliver on its mandate of maintaining price stability," it added.
However, the ECB statement also welcomed some positive aspects of the deal that could strengthen incentives to cut deficits.
Earlier, ECB governing council member Yves Mersch said it was only a matter of time before interest rates increased from their present level of 2 per cent.
"One thing I would like to make clear is that the ECB's governing council is only considering holding rates steady or a rate move up. It is not considering a rate cut," he said.
"If the markets were to have a more negative assessment of the Stability and Growth Pact, this would feed into our decision."
Under the new rules, countries that breach the EU's budget deficit limit of 3 per cent of GDP could avoid punishment if their excessive deficit is caused by a number of factors, including structural reforms, investment in research and development, and the funding of pension systems.
In an important victory for Germany, countries will also be able to cite EU budget contributions and spending on "the unification of Europe" - a coded reference to the cost of German reunification.
Any breach of the 3 per cent limit should be "temporary and limited" but the reform proposal declines to define either term.
Even if a country breaks the budget rules repeatedly, EU finance ministers will be able to postpone the imposition of sanctions indefinitely.
European Commission president José Manuel Barroso said the changes would enhance the credibility of the Stability and Growth Pact rather than weaken it.
"We have rejuvenated the pact. It was a very difficult balancing act and I think the balance has been struck," according to Mr Barroso.
German Chancellor Gerhard Schröder described the deal as "a good political result" and praised the role of his finance minister, Hans Eichel.
However, Germany's Bundesbank said it was "very serious that the framework conditions for the common European monetary policy could be worsened" and described the new rules as "less transparent, more complicated and more difficult to implement". - (Additional reporting, Reuters)
