Interest rates could rise sooner than expected after the European Central Bank (ECB) warned that EU finance ministers risked undermining the budget rules that underpin the euro.
In an unprecedented statement, the ECB's governing council condemned the ministers' decision yesterday not to discipline France and Germany for breaching the Stability and Growth Pact.
Following an emergency teleconference, the governing council hinted that failure to bring budget deficits in France and Germany under control could lead to a rise in interest rates.
"The public can rest assured that the governing council remains staunchly committed to maintaining price stability," the statement said.
Market analysts in Dublin expect ECB interest rates to start moving up next year, and they warn that the expectation that this will happen could push up longer-term bond interest rates moving into 2004 - increasing the cost of fixed-rate mortgages .
After an all-night meeting in Brussels, the finance ministers called on Paris and Berlin to bring their budget deficits below the pact's limit of 3 per cent of GDP. However, they rejected a demand by the European Commission to discipline the EU's two biggest economies under a procedure that could trigger fines if they fail to comply.
The Commission accused the ministers of disregarding rules enshrined in an EU treaty, and expressed deep regret at the decision.
The Minister for Finance, Mr McCreevy, defended the deal, which he said had taken account of political and economic reality.
"I think the Council of Ministers acted in the best interests of Europe. We're here to act in the best interests of the electorate of the various member-states.
"We are not in some Utopian world to try and enforce a set of rules irrespective of the outcome that would have on the population of various member-states."
He said the decision had no implications for next month's budget, pointing out that Ireland still enjoyed economic growth rates of twice the EU average.
Mr McCreevy said that, although the Government would like to see a more flexible interpretation of the pact, yesterday's decision was not an invitation to act irresponsibly.
"It's a totally different situation. What we've been trying to do in Ireland is to try to get the rules of the pact changed regarding what is counted in some of those areas. But we haven't been able to agree on changing the rules. Nor did we today." .
Only four countries - Austria, Finland, the Netherlands and Spain - opposed the decision to spare Paris and Berlin from the disciplinary procedure. The Dutch Finance Minister, Mr Gerritt Zalm, said that yesterday was a grave day for Europe. "The pact does not work. You can read it, but you can't apply it."
Mr Ruairí Quinn, who as minister for finance chaired the difficult negotiations which agreed the pact in 1996, said last night the deal must be renegotiated if it is not to be devalued. "Germany and France have a legitimate case, but they should seek to change the rules, not break them."
Mr Quinn said this was "the first serious confrontation between political leaders through ECOFIN and the European Central Bank". He was surprised Mr McCreevy had not sided with the smaller EU states against France and Germany.
"He will be in the hot seat [as chair of ECOFIN from January 1st] in a very short while", he said, and would have to attempt to renegotiate the deal himself.
Labour's finance spokeswoman, Ms Joan Burton, called on Mr McCreevy to commit himself to use Ireland's imminent EU presidency to establish a renewed pact governing the euro area.
She said Mr McCreevy had adopted a contradictory approach to the current pact. "On the one hand he has refused to countenance borrowing funds up to the level permitted by the existing pact to keep the national capital investment programme at the level he himself announced two years ago.
"On the other hand he exercised Ireland's vote during the night in Brussels to allow France and Germany shred the credibility of the pact."
She said if the present uncertainty was not resolved soon there would be a threat of damaging interest rate increases.
