German Chancellor Angela Merkel again rejected the pooling of debt via eurobonds on Wednesday on the eve of a crunch EU summit to save the euro, as Spain raised the spectre it too could need a bailout.

Just hours before heading to Paris to bridge gaps with French President Francois Hollande, Merkel told the German parliament that pooling debt in the euro area was "the wrong way" and would "repeat the euro's original error."

She said: "Guarantees and controls must go hand-in-hand. There can only be joint liabilities when sufficient controls have been put in place."

Merkel insisted: "Apart from the fact that instruments like eurobonds, eurobills, debt redemption schemes and much more are not compatible with the constitution in Germany, I consider them wrong and counterproductive."

Merkel's Paris meeting is the latest in a rush of shuttle diplomacy to prepare for the Thursday and Friday summit in Brussels that will seek to tackle the short-term crisis and thrash out measures to prevent it occurring again.

The centrepiece of the summit is likely to be a repacking of existing accords into a "growth pact" hailed as amounting to one percent of European output, or about 130 billion euros ($162 billion), which Merkel said was a "strong signal."

But leaders will also seek to define the shape of the embattled eurozone for the next decade, seeking closer integration in the form of a banking union and handing powers to European level for countries' financial sectors and budgets.

"I am under no illusions. There will be controversial discussions in Brussels. And yet again, all eyes, or at least several eyes, will be on Germany," said Merkel.

"But I repeat that Germany's strength is not unlimited. Germany's power is not endless. We should not overestimate Germany's strength," she said.

Merkel warned there were "no quick, no easy" solutions, nor a "magic formula", and called for the problem to be tackled at its roots.

And European leaders were handed a stark warning by crisis-hit Spain earlier Wednesday, whose prime minister, Mariano Rajoy, said his country cannot continue to finance itself at the high rates it currently pays on the markets.

"The most urgent subject is the subject of financing," Rajoy told parliament.

"We cannot finance ourselves for a long time at prices like those we are now paying," he said as the yield on Spanish government 10-year bonds traded at more than 6.8 percent.

The warning raised the nightmare scenario that Spain, the eurozone's fourth biggest economy, might need a full-blown sovereign bailout with dire consequences for the rest of the bloc.

And Rajoy warned that the problem of higher borrowing costs, which already forced Portugal, Ireland and Greece to seek multi-billion-euro bailouts, was not limited to Spain, as markets fear further contagion.

"There are institutions and also financial entities that cannot access the markets. It is happening in Spain, it is happening in Italy and it is happening in other countries," he said.

As if to prove his point, Italy had to pay investors much higher rates of return at a short-term bond auction later Wednesday.

The government sold a total of nine billion euros worth of six-month bonds at a yield of 2.957 percent compared to 2.104 percent at the last similar operation on May 29, the Bank of Italy said.

And in further evidence that the debt crisis is seeping through into the real economy, Spain's central bank warned that the country's crippling recession was deepening.

After economic output shrank by 0.3 percent in the last quarter of 2011 and again in the first quarter of 2012, latest data showed further contraction in the second quarter "at a more intense pace", it said.

Not even Merkel's economy - Europe's biggest - appeared to be immune from the crisis.

Although Germany has generally fared better than most, small US credit rater Egan-Jones lowered its rating Tuesday, saying the European powerhouse's finances would suffer significantly whether or not Greece quits the eurozone.

Nonetheless, there were some bright spots on the dark horizon.

Confidence in the Italian manufacturing sector unexpectedly rose in June, according to data published on Wednesday and stocks were generally in positive territory in midday trade, after solid gains in Asia.

At midday, London's FTSE-100 index was up 0.32 percent at 5464.35 points. Germany's DAX was also trading up, by 0.12 percent at 6143.90 and France's CAC-40 was up 0.25 percent at 3020.34.

Spanish and Italy markets were also up around 0.50 percent.

channelnewsasia.com