Euro bailout wrangles spook markets as fears of slump intensify

Fears intensified of a fresh global slump on Tuesday as it emerged that Europe's leaders were still at loggerheads over a three-pronged plan to save the single currency.

Hopes that summits in Brussels on Wednesday would deliver a "grand bargain" that would finally draw an end to an 18-month sovereign debt crisis were fading fast as talks planned for Wednesday morning were cancelled, rumours surfaced of a collapse in Silvio Berlusconi's Italian government and the German chancellor, Angela Merkel, adopted a hard line in negotiations with her French counterpart, Nicolas Sarkozy, over the shape of a rescue package.

The lack of progress forced the cancellation of a meeting of the EU's 27 finance ministers, including Britain's George Osborne, in Brussels on Wednesday.

However, two meetings – the first involving leaders of all 27 European Union countries and the second limited to the 17 members of the single currency – are expected to proceed, to the despair of several EU diplomats.

"Everybody realises that we are on the brink of such a total catastrophe that anything that prevents it and a huge recession must be grasped," one EU diplomat said. "The markets will kill us if they haven't laughed themselves to death."

Shares have been rising in the past few days amid speculation that Wednesday's meetings, delayed from the weekend to give officials more time to piece together a deal, would agree the terms of a Greek debt write-down, bolster the firepower of Europe's bailout fund – the European Financial Stability Facility (EFSF) – and pump up to €108bn into Europe's weakest banks. Negotiations continued into the night on each strand.

But with receding expectations of a deal, even in political outline, that could be signed, sealed and delivered by early Thursday, sources said the only hope of a "miracle" lay in a meeting of senior euro working group officials late on Tuesday.

Shares fell sharply late on in Europe and in New York as evidence of a potential failure began spooking markets. At a Senate hearing in Washington, Charles Collyns, a senior US treasury official, said: "The European financial crisis presents the most serious risk today to global recovery and the prospects for US exports and American jobs."

But he said: "We do think they are going to take action comprehensively in the next few days." The US has been putting intense pressure on Europe to "get its act together" amid concerns that the crisis will push the world economy into a double-dip recession. Washington is eager for a deal to be agreed before Barack Obama travels to Cannes for next week's summit meeting of the G20 group of developed and developing countries.

Such was the gravity of the situation on Tuesday night that there were reports that the International Monetary Fund was considering putting money into the EFSF to spare cash-strapped European governments the cost of adding more capital to the €440bn (about ￡380bn) facility. The IMF believes Europe needs to have €2tn at its disposal to head off market pressure on the two big problem countries, Italy and Spain, and has been exploring with Brussels ways of leveraging up the EFSF's resources.

A suggestion doing the rounds of Brussels corridors is that Wednesday'ssummit could reach a last-minute political agreement, leaving finance ministers to sort out the complex technical issues later this week – perhaps even at the weekend.

But this has already prompted analysts to question whether the EU can ever get its act together and be ahead of the market curve. "The job facing European leaders is no small one and can be likened to climbing Everest without crampons," said Angus Campbell at Capital Spreads.

Brian Barry, a bond market expert at Evolution Securities, said: "It's coming down to the wire. It's about restoring confidence. There has been very little so far to do that. Something has to be done. If this doesn't work to restore confidence it will be quite worrying."