Franco-German call for 'true euro economic governance'

The French and German leaders have called for "true economic governance" for the eurozone in response to the euro debt crisis.

Speaking at a joint news conference, German Chancellor Angela Merkel and French President Nicolas Sarkozy urged much closer economic and fiscal policy in the eurozone.

Ms Merkel said that further integration would be a "step-by-step" process.

They also advocated a tax on financial transactions to raise more revenues.

The two leaders said they wanted bi-annual meetings of the 17 heads of the eurozone governments, chaired by Herman van Rompuy, the current president of the European Council.

Markets reacted negatively to the conference, with some investors saying that they were expecting bigger announcements.

In New York, the Dow Jones Industrial Average fell 1.3% during and after the press conference, which took place after the close of trading in Europe, but recovered later.

Government bonds in the US and Germany - seen as safe havens in any economic downturn - rallied in reaction to the leaders' comments.

Ms Merkel again played down the chances of introducing "eurobonds" - jointly guaranteed debts of the 17 eurozone governments - as a solution to the crisis.

The idea has been advocated by the Italian finance minister, Giulio Tremonti, as well as billionaire investor George Soros as a way of providing cheap financing to struggling governments while also incentivising them to put their finances in order.

But the German chancellor said she only saw such a move coming at the end of a long process of fiscal union.

Instead, Ms Merkel proposed that a requirement for eurozone members to balance their budgets should be enshrined in each of their constitutions.

"We will regain the lost confidence," she said. "That is why we go into a phase with a new quality of co-operation within the eurozone."

In another initiative to increase tax revenues, the leaders advocated harmonising corporate tax rates across the single currency - something likely to be strongly opposed by the low-tax Republic of Ireland.

However, Germany's insistence on government austerity across the eurozone has been criticised by some economists for undermining the economic recovery.

The two leaders were meeting in Paris in the wake of last week's turmoil on the financial markets, which came amid fears of a renewed global recession and over the ability of Spain and Italy to repay their debts.

Earlier on Tuesday, Germany revealed that its economy grew by just 0.1% in the three months to June, much more weakly than previously thought.

Germany had been driving the economic recovery in the eurozone.

Both French and German leaders, along with the European Central Bank, are putting pressure on so-called peripheral economies to extend austerity measures to try to balance their budgets.

Major economies are also making cuts - Italy announced tougher austerity measures designed to reduce its budget deficit on Friday, while Spain has also said it will speed up spending cuts.

However, there are fears that spending cuts by governments - something strongly advocated by Germany - will undermine overall economic growth.

In an article published in the Financial Times newspaper, the head of the International Monetary Fund, Christine Lagarde, warned governments that they must balance spending cuts with measures to support growth to avoid the risk of a double-dip recession.

Ms Lagarde acknowledged the need for governments to reduce debt levels, but said "slamming on the brakes too quickly would hurt the recovery and worsen job prospects".

It could also undermine further the confidence of international investors, she said.