The European Council agreed last week to reform the Stability Pact, ratifying proposals made by EU finance ministers. The pact was designed to protect the stability of the euro by preventing excessive borrowing amongst member states of the euro zone.

It limits a country's general government deficit to below 3 per cent of GDP, proscribing fines for euro zone countries that breach this rule.

Critics have pointed to the fact that the pact punishes deficits while effectively ignoring the size of a country's debt and the threat of Europe's growing pensions' burden.

It has also been argued that, by handing the power of policing its provisions to EU heads of government rather than to the more neutral European Commission, it was destined never to be fully enforced.

In 2003, France and Germany were able to successfully lobby a majority of other member states to suspend the pact's corrective procedures, after they breached the 3 per cent limit.

This followed the full implementation of the pact against Portugal, prompting accusations that it was being inconsistently applied. The agreed reform aims to end this inconsistency and, ostensibly, improve the focus and workings of the pact.

For instance, the GDP growth threshold defined for excusing countries from sanction is eased from -2 per cent to any rate of growth that is "negative" or "low relative to potential growth".

In this way, the pact aims to take more account of a country's economic difficulties before punishing excessive deficits.

In a move that will benefit Ireland, the old pact's requirement for budgetary balances to be "close to zero" in the medium-term is relaxed to permit a medium-term deficit of around 1 per cent.

This change is aimed at accommodating countries with low debts and high growth rates that need to invest in public infrastructure, such as Ireland and the new member states of the EU.

However, many of the agreed changes are defined in language that is more open to interpretation. One such change permits the pact to take account of the costs of "the unification of Europe", a coded reference to German unification.

German Chancellor Gerhard Schroder insisted on such a change, in spite of Germany having made no such request in 1996 when the pact was first negotiated. The exclusion of the costs of pension reform and structural reform are also permitted by the reforms.

Critics also say that the use of such vague language offers too many get out clauses for errant governments. The European Central Bank reacted to the initial Ecofin proposals by expressing its "serious concern" that reforms could undermine the sustainability of public finances.

The German Bundesbank issued a similar statement.

However, the ECB has acknowledged that some of the proposals are positive. These include efforts to strengthen the hand of the commission over the council in policing the pact, as well as efforts to assess and focus more on Europe's problems of rising pension costs, hidden public liabilities and consequent growing debt burden.

In the medium-term, Ireland gains from the reforms in having more freedom on the capital spending side. The pact has not been a binding constraint on public investment in the past, but the revision of the pact's "medium-term balance" rule should permit the Government more room for manoeuvre in the future.

This will be needed if, as predicted by the CSO, Ireland's population grows from four to five million in the coming 15 years.

In the long-term, the more porous nature of the pact's language will render it more difficult to implement. Capital markets have already sent negative signals about the solvency of public finances in Germany and Italy by downgrading the credit ratings of those countries' bonds.

As well as intensifying concerns in the case of these countries, the pact's reform may spread them to other member states that might be tempted to test its flexibility.

Evidence suggests that this may already be starting: The euro declined to one-month lows against the dollar in the wake of the decision, while German long-term bond yields have risen further.

Interest rates implied on six-month Euribor futures contracts have also risen slightly, suggesting that the markets now believe an ECB rate rise by September is more likely.

Factors other than pact reform may be more relevant to these trends, including continued monetary tightening by the US Federal Reserve as well as disappointing recent German business sentiment data, but these reforms do little to help the credibility of public finances in the EU.

Ireland will not suffer from these developments, provided that our debt levels do not increase by excessive amounts.

However, Ireland could suffer in other ways. The ECB has yet to fully react to Wednesday's events.

An immediate rise in its policy rate is probably out of the question, but signals from governing council member Yves Mersch suggest that the pact's reforms now eliminate any possibility of a rate cut, as predicted by some.

Furthermore, if the pact's reform results in fiscal abandon in high-debt countries, then rate rises may come faster and harder than otherwise.

Many international economists feel that rates are already too low for present monetary conditions and point to the growing threat of asset price bubbles in countries such as France, Spain and Ireland.

They have waited for the opportunity to argue for ECB rates to be corrected in an upward direction and the pact's reform may be the answer to their prayers. As always, there is a political dimension: EU leaders attending the summit were conscious of the need to maximise support for the constitution amongst the voters of countries where referendums will be held, such as France and Ireland.

This helped to colour decisions relating to the Stability Pact, as well as changes in the draft Services Directive.

If French voters confound recent opinion polls and ratify the draft constitution, attention will turn to Ireland, as the Government prepares to convince Irish voters to go the same way.

It would be less than helpful to that effort if, by then, Irish mortgage holders were suffering the consequences of higher interest rates brought about by reform of the pact.

Marc Coleman is a former ECB economist and is presently on scholarship at the Michael Smurfit Graduate School of Business.