Under pressure to prevent a catastrophic breakup of their single currency, Euro Zone leaders agreed on Friday to let their rescue fund inject aid directly into stricken banks from next year and intervene on bond markets to support troubled member states.

They also pledged to create a single banking supervisor for Euro Zone banks based around the European Central Bank (ECB) in a landmark first step towards a European banking union that could help shore up struggling member, Spain.

“It’s a first step to break the vicious circle between banks and sovereigns,” European Council President Herman Van Rompuy told a final news conference after talks which stretched right through the night.

The deal was widely seen as a political victory for embattled Italian Prime Minister Mario Monti and his Spanish counterpart Mariano Rajoy over German Chancellor Angela Merkel, who had brushed aside any need for such emergency measures earlier this week. ECB President Mario Draghi endorsed the tangible results, which sent the euro nearly two per cent higher and sharply cut Spanish and Italian bond yields.

European shares rose, led by banking stocks buoyed by the prospect of moves to backstop the financial system. “I’m actually quite pleased with the outcome of the European Council. It showed the long-term commitment to the euro by all member states of the euro area,” Draghi told reporters.

Market participants welcomed the outcome as a substantial step to restore confidence in the 17-nation Euro Zone, which was saluted by a more durable rally than previous summit outcomes. “It’s inching closer to a banking union, and the closer we get to a banking union would put the EU well on the road to a fiscal union,” said Art Hogan, managing director of Lazard Capital Markets in New York.

Most economists polled by Reuters expect the ECB to cut borrowing costs at its July 5 meeting, which takes place against a darkening economic backdrop. But internal resistance to the central bank reviving its bond-buying programme remains high.

The 17 leaders agreed on a series of short-term steps to shore up their monetary union and bring down the borrowing costs of Spain and Italy, seen as too big to bail out.

It gave few specifics, but Euro Zone officials said the funds could buy bonds on both the primary and secondary markets on the basis of a memorandum of understanding signed with the requesting state and up to a funding limit to be agreed. Both Italy and Spain said they

did not intend to call on that mechanism to stabilise markets for now, hoping the Brussels agreement will serve as a sufficient deterrent.

Washington said it was encouraged by the progress but White House Press Secretary Jay Carney told reporters travelling with President Barack Obama that a lot of details still needed to be worked out, and the Euro Zone was likely to need to take further steps in the future.

Monti, determined to avoid the political stigma of the bailout terms imposed on Greece, Ireland and Portugal, said countries that complied with EU budget recommendations would not face extra austerity conditions or be subject to intrusive inspections by a troika of international lenders. Eager to avoid the impression that she had blinked first, Merkel said strict conditionality would still apply to the use of rescue funds and countries would face stringent monitoring by the EU Commission and the ECB.

Asked if she had yielded to pressure, she said, “There is clearly pressure from financial markets. Some countries are in a

difficult situation. The high interest rates affect the debt but also the real economy. We had an interest in finding solutions.”

Merkel reaffirmed her firm opposition to common Euro Zone bonds.

The Spanish and Italian leaders had threatened to block a package of measures to promote growth to pressure Merkel to

accept measures to ease their borrowing costs, delaying the talks. New French President Francois Hollande backed their calls for bold steps to help the bloc’s third and fourth biggest economies, adding to the pressure on Merkel.

Economists applauded both the short-term measures to steady markets and the longer-term direction, saying that for once, after 20 summits since the crisis began in early 2010, Euro Zone leaders had exceeded admittedly

low expectations.