By Paul Carrel and Francesca Landini
COPENHAGEN (Reuters) - Euro zone finance ministers agreed on Friday on a temporary increase in their financial rescue capacity to prevent a new flare-up of Europe's sovereign debt crisis, but markets may judge it too small to be convincing.
Austrian Finance Minister Maria Fekter said the 17-nation currency area would combine two rescue funds for a year to make more money available in case of emergency.
She put the total figure at some 800 billion euros, but that appeared to include money already spent to conjure up a more impressive headline number for investors.
"Obviously markets will only have confidence in us if we agree on a strong rescue fund," Belgian Finance Minister Steve Vanackere told reporters.
"We can't consider that the crisis is over. We must find a good middle way between those who seek a (maximum) firewall and those who want it kept to a minimum."
A draft statement prepared for ministers and obtained by Reuters [ID:nL6E8ET5NA] showed that in case of need before July 2013, the euro zone could combine the firepower of its two bailout funds to provide 940 billion euros rather than a planned 500 billion.
Ministers would allow the temporary 440-billion-euro European Financial Stability Facility (EFSF) to continue to run for a year in parallel with the permanent 500-billion-euro European Stability Mechanism (ESM), which starts work in July.
However, EU paymaster Germany favored a smaller increase, and those figures included some 192 billion euros already paid or committed to Greece, Ireland and Portugal, plus money that could only be raised if euro zone states were to pay in more capital faster than planned to the ESM.
Fekter said the residual 240 billion euros from the EFSF would be used as a reserve buffer while the two funds run in parallel and the ESM's capital is being built up.
Bond market players questioned whether the likely compromise would provide sufficient money to help Spain, the euro zone's number four economy, if it needs a bailout to overcome a banking crisis due to the collapse of a real estate bubble.
"At the end of the day the key question is whether this new firepower is enough," said Steve Barrow, head of G10 strategy at Standard Bank in London. "Clearly if things turn down again, and especially if more bailouts are needed, the tricky issue of underfunding the ESM/EFSF relative to the potential bailout need is bound to resurface."
Commerzbank analyst Christoph Weil said the proposed boost, combined with extra assistance from the International Monetary Fund, would probably be big enough to "offer shelter to Spain and Italy if necessary".
"Nonetheless, there is reason to fear that investors will remain skeptical and continue to demand high risk premiums for peripheral bonds," he wrote in a note.
The residual EFSF funds - about 240 billion euros - could only be called on if the ESM, which will initially have 200 billion euros available to lend, ran out of money to finance a new bailout during that period.
Countries sharing the euro have already agreed to adopt more strictly enforced balanced-budget rules in an effort to convince markets that their public finances will be sustainable.
They also agreed to slap fines on countries that run excessive budget deficits or have large imbalances in their economies.
Spain, which has rejected all talk of seeking assistance, was set to unveil a tough austerity budget on Friday designed to reduce its public deficit to 5.3 percent of gross domestic product this year from 8.5 percent in 2011 despite a recession.
"This is a budget that will be convincing, I am sure of that, and show the Spanish government's commitment to austerity and fiscal consolidation," Economy Minister Luis de Guindos said in Copenhagen.
He played down a general strike and mass street protests on Thursday that highlighted the scale of opposition to a new labor law making it easier to fire workers and dismantling collective wage bargaining. Hundreds of thousands of Spaniards marched in protest, with violence flaring in Barcelona.
Spanish bond yields rose again amid market doubts about Madrid's ability to implement reforms and repair public finances threatened by the recession and the banking crisis, at a time when unemployment is already 23 percent, the highest in the EU.
After a deal with investors this month to restructure Greek debt, increasing the amount of money the euro zone can provide to help members cut off from markets is seen as the next step to boost investor confidence.
In another move to ease the immediate crisis, Ireland managed to avoid a 3.1 billion euro payment to one of its failed banks, settling the bill by issuing a 13-year bond, Finance Minister Michael Noonan announced on Thursday.
CONDITION FOR MORE MONEY FOR THE IMF
The European Commission and several of the world's biggest economies have been pushing to increase the euro zone bailout capacity as much as possible, in the belief that once investors see a wall of money supporting euro zone debt, confidence would return and the rescue funds would never have to be used.
But Germany, where public opinion is hostile to bailouts, has been against raising the contingency funds, noting that markets have calmed down from the peak of the debt crisis.
Yet market concern about Spain, which badly missed its budget deficit target in 2011 and negotiated with the euro zone a softer target for 2012, have put the bailout capability discussion back on the table.
A higher euro zone bailout capacity is a pre-condition for most G20 countries to contribute more money to the IMF.
Euro zone diplomats are confident that the proposed temporary boost will be sufficient to unlock an additional 500 billion euros in contingency funds for the IMF.
The ministers are also to say that they will continue to review the adequacy of the ESM capital "as appropriate" and "in particular when used EFSF guarantees are freed once financial assistance is repaid".
(Additional reporting by Annika Breidthardt and Robin Emmott in Copenhagen, Swaha Pattanaik and Anirban Nag in London; Writing by Jan Strupczewski and Paul Taylor; Editing by Philippa Fletcher)