ANALYSIS: The stability pact, as currently written, is dead. Its rules cannot now have any legitimacy, following yesterday's decision of euro-zone finance ministers.

The questions now are whether there will be an attempt to revise the pact - and in the longer term what impact the affair will have on the euro project.

By deciding to let France and Germany "off the hook" and not subject them to the rules of the pact, the EU finance ministers have effectively abandoned the 3 per cent deficit limit.

The two biggest states are now set to break the limit for the third year running in 2004, but despite this, the ministers agreed to drop disciplinary action against them in return for political commitments to meet the target in 2005.

The abandoning of the current financial framework received a hasty rebuke from the European Central Bank. The ECB is likely to be not so much worried about the immediate impact on French and German deficits - but more about whether this is a first step on the proverbial slippery slope to fiscal laxity.

Economic analysts Mr Colin Hunt of Goodbody and Mr Austin Hughes of IIB yesterday agreed that an increase in ECB interest rates has now come a bit closer, but will still not occur until next year. Mr Hughes expects euro rates to rise by 0.75 of a percentage point in 2004, with the first increase coming around mid-year.

The initial reaction on financial markets was muted, with longer-term interest rates just ticking up slightly and the euro easing fractionally. However, if the euro-zone economic recovery picks up, expectations of rising ECB rates later in 2004 could push longer-term market rates - or bond yields - higher moving into next year, pushing up the cost of fixed-rate mortgages to new borrowers.

Looking to next week's Budget, the Minister for Finance, Mr McCreevy, could in theory push borrowing higher without fear of any meaningful rebuke from Brussels. He is most unlikely to do so, though in justifying a low borrowing target he will now have to rely on arguments for prudence, rather than the need to adhere to EU rules.

For the future, the effective death of the pact in its current form may open up some increased flexibility for budget policy, particularly in terms of borrowing to fund investment. Any reform of the pact is likely to recognise that countries should be given more latitude for worthwhile investments, which, unlike borrowing for current purposes, yield an economic return. Much will now depend on whether a move to reform the pact gets under way, or whether the fall-out from the current row makes this impossible in the short term.

Mr McCreevy will be relieved that he is not now faced with chairing a council of finance ministers in the first half of next year that is moving towards imposing fines on France and Germany.

The Minister has publicly supported the pact, but when it came to the crunch early yesterday morning he decided to vote against taking action against France and Germany, no doubt reckoning that there was no mileage in opposing the big two.

The Irish presidency may now be forced to consider a reform of the pact. If this is to be done it would be likely to happen before the new EU Constitution is finalised, which means it must be hammered out early next year.

The original pact was finalised in talks in Dublin chaired by the then finance minister, Mr Ruairí Quinn, during the 1996 Irish presidency; perhaps the reform will also be hammered out here.

Or maybe Mr McCreevy will try to strike a deal when the EU finance ministers meet in Punchestown. (The Punchestown Pact has a ring to it.)

Reform now seems the best way forward. But it is not inevitable. The EU Commission, hugely upset by yesterday's decision, could try court action to enforce the existing rules.

However, this would up the ante considerably and would provoke a direct battle between the Commission and the majority of EU finance ministers, who are already resisting proposals to give the Commission more powers as part of the new EU Constitution. Any whiff of such a crisis would unsettle the financial markets, who are already wondering about the longer-term impact on euro-zone assets.

The Stability and Growth Pact was flawed - for example allowing no room for flexibility for capital investment and no consideration of debt levels. However, by abandoning it in the middle of a big row, the EU finance ministers have taken a dangerous course.