Euro zone officials agreed on Friday on the terms of a possible financial rescue for Greece as a credit ratings agency downgraded Athens' debt by two notches, citing a worsening economy and rising borrowing costs.
Deputy finance ministers and central bankers of the 16 countries sharing the European single currency decided that any emergency loans would be made on terms almost identical to standard IMF bailouts if Greece needed them, an EU source said.
"A deal has been reached," the source with close knowledge of the discussions told Reuters. "It is almost a carbon copy of International Monetary Fund terms."
But the news brought only momentary relief on credit markets because Fitch Ratings cut Greece's credit rating to BBB negative and signaled further downgrades are possible, citing intensifying fiscal challenges in the debt-plagued country.
New figures published on Friday highlighted a deepening recession that will further aggravate those problems as the government continued to resist market pressure to seek outside help with its debt crisis.
EU newcomer Bulgaria meanwhile delivered a second shock to the euro zone by delaying plans to join the currency after admitting that, like Greece, it had lied about its 2009 deficit.
After investors dumped Greek assets this week due to growing doubts over the euro zone/IMF rescue plan, the risk premium on Greek bonds compared to benchmark German bunds briefly dipped below 400 basis points on news of the Brussels deal. (One basis point is equivalent to 0.01%, or one-hundredth of a percentage point.)
Euro zone officials, including the leaders of France and Italy, sought to reassure markets that the financial safety net agreed in principle at an EU summit last month, would be ready if it became needed.
"We are ready to take action at any moment to come to the aid of Greece," French President Nicolas Sarkozy said after talks with Italian Prime Minister Silvio Berlusconi.
First details of the Brussels agreement suggested Germany and the Netherlands had eased their insistence that rescue loans to Greece be at close to current punitive market rates.
The EU source said that loans terms would be close to IMF terms on three-year credits of 300 basis points above the concessionary Special Drawing Rights rate (151 basis points), plus a 50 bps service charge.
That would be a rate of 5.01 percent, higher than Greece had hoped but well below the current market rate of 7.3 percent, according to Tradeweb data.
The European Commission and the European Central Bank would propose the amount and maturity of the loans depending on Greece's funding needs, the source said.
Any disbursement would require the unanimous agreement of the 16-nation euro zone.
Greek bank shares gained more than 7 percent on word of the euro zone deal after Thursday's 6 percent fall.
"This reduces the country risk and investors have closed short positions in bank stocks," said Takis Zamanis, chief trader at Beta Securities.
However, news that industrial output fell by 9.2 percent year-on-year in February while inflation spiked to 3.9 percent in March underscored the dire economic background to the fiscal crisis that has shaken confidence in the euro zone.
The Greek economy is officially forecast to contract by 2 percent this year after a similar fall in 2009, but some economists now expect the decline to be even sharper.
That would make it harder to reach a promised budget deficit cut of four percentage points of gross domestic product this year and to sustain the fiscal adjustment over several years.
Earlier, Finance Minister George Papaconstantinou said bond spreads of more than 400 basis points did not reflect the real state of the economy or the government's austerity measures.
Asked by reporters after meeting Prime Minister George Papandreou whether Greece wanted the aid plan activated, he said: "No. This issue has not been raised... we have said that Greece does not intend to use this mechanism." However, financial markets are increasingly betting on an early resort to the rescue fund.
UBS currency strategist Geoffrey Yu said it could be "days, rather than weeks" before the IMF comes to the aid of Greece.
Greece needs to borrow about 11 billion euros ($14.79 billion) by the end of May to finance maturing debt and interest payments. Its overall borrowing requirement for this year is 53 billion euros.
The next test will come on Tuesday, when it will auction 1.2 billion euros in six- and 12-month T-bills, a government official said.
Goldman Sachs chief European economist Erik Nielsen said in a note issued on Thursday he expected an 18-month aid program by the end of April worth 20 billion to 25 billion euros ($26.90 billion to $33.62 billion), co-financed by the euro zone and the International Monetary Fund.
European Central Bank president Jean-Claude Trichet said in a newspaper interview that Greece was not at the point where it needed a financial bailout and default "is not an issue".
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