EU Monetary Affairs Commissioner Mr Pedro Solbes, warning that a decision to halt budget discipline enforcement against France and Germany could affect bond markets and interest rates, said yesterday he would propose a mechanism better adapted to economic reality.

Mr Solbes told the European Parliament that last week's finance ministers' decision to suspend sanctions against Berlin and Paris had created a "very bad precedent" for the 10 countries that join the bloc next year.

"Not correcting the excessive deficit rapidly will in the medium term have an impact on the bond markets and on interest rates," he said in testimony to parliament's Economic and Monetary Affairs Committee.

"The damage inflicted on the Stability and Growth Pact and the persistence of high deficits are likely to hurt economic growth in the medium term," he said.

But he said the impact would not be immediate and the EU could take advantage of the crisis unleashed last week to come up with realistic rules to prevent a fiscal free-for-all.

"At the end of the day, we need to take advantage to emerge with a viable pact, a pact that's unchanged in its substance but better adapted to economic circumstances that can emerge," Mr Solbes said.

The stability pact, adopted in 1997 to underpin the euro, limits member states' budget deficits to 3 per cent of gross domestic product and provides for a series of sanctions, leading ultimately to huge fines, for persistent offenders.

Mr Solbes said the EU executive would prepare an initiative on better economic governance taking into account the current debate on how to improve the pact's rules. New ideas were "emerging from the woodwork" to reshape the rules, including taking account of inflation, public debt and investment spending, or incorporating clearer obligations to make provisions to reduce debt in good economic times.