BRUSSELS/TOULON, France (Reuters) - The new head of the European Central Bank signaled on Thursday it stood ready to act more aggressively to fight Europe's debt crisis if political leaders agree next week on much tighter budget controls in the 17-nation euro zone.
In France, President Nicolas Sarkozy called for a new treaty incorporating tougher budget discipline, a European Monetary Fund to support countries in difficulty and decisions in the euro area taken by majority vote instead of unanimity.
Addressing supporters in the port city of Toulon, Sarkozy said he and German Chancellor Angela Merkel would meet next Monday to outline joint proposals to put to a December9 EU summit, seen as make-or-break for the 12-year-old single currency.
"Let us not hide it, Europe may be swept away by the crisis if it doesn't get a grip, if it doesn't change," Sarkozy said, warning that a collapse of the euro would make France's debt unmanageable and wipe out people's savings.
"We don't have the right to let such a disaster happen."
ECB President Mario Draghi painted a dark picture of the state of Europe's banking system, speaking a day after the world's major central banks took emergency joint action to provide cheaper dollar funding for starved European banks.
"A new fiscal compact would be the most important signal from euro area governments for embarking on a path of comprehensive deepening of economic integration. It would also present a clear trajectory for the future evolution of the euro area, thus framing expectations," he told the European Parliament.
Draghi did not spell out what action the ECB might take, saying only a commitment by political leaders to stricter budget discipline and binding their economies more closely "is definitely the most important element to start restoring credibility. Other elements might follow, but the sequencing matters."
In the short-term, economists expect the central bank to relieve pressure on banks and an economy heading into recession by cutting interest rates next week and announcing longer-term cheap liquidity tenders with easier collateral rules. Markets are pricing in a 25 basis point cut to 1.0 percent on December 8.
Draghi, who faces some of the toughest decisions in the currency's 12-year history after just one month in the job, said the ECB was aware many European banks were in difficulty because of stress on sovereign bonds, tight inter-bank funding markets and scarce collateral.
"Downside risks to the economic outlook have increased," he said, noting that the ECB's mandate was to maintain price stability "in both directions" -- a rare indication that the bank is concerned about deflation risks as well as inflation.
Sarkozy voiced similar sentiments in words designed to reassure voters anxious about handing more power to Brussels. He called for an "intergovernmental" Europe and made no mention of the stronger role for the European Commission or the European Court of Justice sought by Berlin.
"Sovereignty can only be exercised with others. Europe doesn't mean less sovereignty but more sovereignty because it gives us a greater capacity to act," Sarkozy declared.
His Socialist opponents in next year's presidential election denounced an "austerity treaty" imposed by Germany.
Merkel is due to outline her own vision in an address to parliament in Berlin on Friday. Aides said the leaders conferred by telephone to ensure that their speeches, while different in tone, would not be incompatible.
Sarkozy avoided calling directly for massive ECB action to buy bonds of troubled euro zone states or cut interest rates. But he said: "Naturally the European Central Bank has a decisive role to play ... I am convinced that faced with the risk of deflation with threatens Europe the central bank will act."
Two years into Europe's debt crisis, investors are fleeing the euro zone bond market, European banks are dumping government debt, south European banks are bleeding deposits and a recession looms, fuelling doubts about the survival of the single currency.
The euro and European stocks extended gains after surging on Wednesday upon the joint dollar liquidity move by the U.S. Federal Reserve, the ECB and the central banks of Japan, Britain, Canada and Switzerland.
Markets were cheered by strong demand at Spanish and French bond auctions on Thursday. France's 10-year bond spread over safe haven German Bunds fell below 100 basis points for the first time since October 28 after peaking above 200 bps in mid-November.
A group representing many of the world's top private banks added its voice to the calls for action from the ECB. "The crucial role of the ECB in ensuring normal liquidity conditions in the Euro Area sovereign and financial debt markets cannot be overstated," the Institute of International Finance's market monitoring group said in a statement.
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