Merkel, Sarkozy to speak as crisis rages

Europe's debt crisis and fears over the US economy battered markets once again Friday challenging vacationing European leaders to come up with a way to keep the turmoil from pushing Spain and Italy to financial collapse.

Stocks fell across Europe, following an earlier slide in Asia, and Italian and Spanish bonds traded at levels that threaten their ability to raise money in the bond markets to pay off debts. Those debt fears are compounded by concerns the United States, the world's biggest economy, will slide into another recession.

How the markets actually end the week could well hinge on upcoming U.S. jobs data later. Nonfarm payrolls are expected to rise by around 90,000 in July. Anything disappointing could accentuate the slide and reinforce worries that the markets are suffering their biggest meltdown since October 2008 after the collapse of U.S. investment house Lehman Brothers stoked worries over the global financial system.

In Europe, German Chancellor Angela Merkel, vacationing in the Italian Alps, and French President Nicholas Sarkozy, on the French Riviera, are interrupting their summer holidays for a phone conference on the crisis, Merkel's office said.

Sarkozy's office said he would also speak with Spain's Prime Minister Jose Luis Rodriguez Zapatero.

Spanish and Italian bond yields have risen above 6 percent, approaching the levels that drove much smaller Greece, Portugal and Ireland to seek bailouts from the eurozone and the International Monetary Fund.

Fears that a country may default drive up the interest yields on its bonds. That can become a vicious spiral as the higher rates increase the scale of the debt and frighten away even more bond investors.

European leaders face few and difficult options. They gave their euro440 billion rescue fund new powers to prop up bond markets and rescue banks at a July 21 summit, but the changes are not in effect yet because national parliaments have not approved the measures yet. That leaves the European Central Bank, which has been reluctant to buy government bonds because it does not want to be seen as supporting shaky government finances.

A longer-term option would be a eurobond whereby the 17 members of the currency union borrow jointly. But that has firmly been rejected by German and other countries with strong finances since it would mean they would pay higher interest rates.

The market turmoil worsened Thursday after the head of the European Commission, Jose Manuel Barroso, warned that governments needed to move more quickly to implement the new powers for the bailout fund, and after the European Central Bank made only limited purchases of Portuguese and Irish bonds - but not those from Italy or Spain - in an attempt to steadying markets.

The bank also offered new emergency credit to shaky banks. But those moves failed to stop the turmoil.

Commerzbank chief economist Joerg Kraemer said that for now the ECB appeared the only line of defense.

"At present only the ECB would probably be able to buy bonds from the ailing peripheral countries and effectively counteract a potential escalation of the sovereign debt crisis," said Kraemer. "If worst came to worst, we would expect the central bank to do just that, although this would in fact mean financing public spending by printing money."

Currently, the central bank has drained money from the financial system when it buys bonds to ensure that its purchases do not expand the supply of money in the economy.