World markets rose and the cost of borrowing for key countries fell on the news that a new deal had been struck to recapitalise European banks.

Italy saw its shares rise all day, closing up 6%. Spain too, saw a 6% rise on its main share index.

French and German shares were up by over 4% and in Dublin the ISEQ rose by 2%. Elsewhere markets also rallied - with US shares up by about 2%.

This came after after European Union member states approved an economic growth package and devised a deal to ease the recapitalisation of struggling banks.

The move will also see a single supervisory body for Europe's banks, which will be able to help the banks without adding to the sovereign debt of nations.

The cost of borrowing for Ireland, Italy and Spain has fallen following news of the deal.

The Governor of the Central Bank Patrick Honohan said that the summit decision pushes forward the process of breaking the vicious cycle of high interest rates on Government bonds in Europe.

The political agreement opens the way for money put into Irish banks to no longer be counted as national debt. At present the Troika lends to the State and the State put money into the banks. The agreement would see Europe's bailout mechanism the ESM would put money into the banks although it will still have to be repaid.

Finance Minister Michael Noonan has welcomed the agreement last night at the European summit as very significant and ''a very good news story for Ireland''.

Speaking on RTÉ he said that there had been a total change of policy in Europe, that countries will be treated more advantageously as they fulfil commitments.

What we have to do now, he said, is to go through a process of working out the mechanism and details.

He said the Government's negotiating position had been to reduce the bank debt on the State's balance sheet - but this went much further. He said the deal broke the link between bank debt and sovereign debt.

The breakthrough came in the early hours of this morning during a dramatic impromptu summit of euro zone leaders in Brussels.

According to a statement issued at 4am, euro zone leaders pledged to "examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment programme."

ESM to directly recapitalise euro zone banks

Following intensive negotiations, first at official level and then at heads of government level, it was agreed that the EU's permanent bailout mechanism could be used to directly recapitalise euro zone banks.

This had been a key demand of the Spanish and other governments in the run up to this week's crisis summit. It was vigorously supported by the Irish Government as a way to potentially restructure Ireland's bank debt retroactively.

The agreement follows months of trenchant German opposition to the use of the European Stability Mechanism (ESM) to directly recapitalise banks. It states that once an EU-wide bank supervision system is set up the ESM will be able to directly recapitalise banks.

According to Irish officials, this represents a "seismic shift" in EU policy. Taoiseach Enda Kenny said that once the new supervision system is in place, Ireland's overall debt burden, including the bank debt burden, can be re-engineered in a way which will give Ireland equal treatment to Spain and any other countries which avail of the new system.

EU President hails ''real breakthough'' in euro crisis

Following the tense talks that stretched into the early hours, EU president Herman Van Rompuy told reporters a "real breakthrough" had been struck to calm financial markets and reshape the euro zone to prevent the crisis recurring.

European Commission President Jose Manuel Barroso hailed a "very ambitious decision that shows once again the commitment of the member states to the irreversibility of the euro and I think this will be recognised by all."

The accord paves the way for the euro zone's €500 billion bailout fund to recapitalise ailing banks directly, without passing through national budgets and adding to struggling countries' debt mountains. This however, would occur only after a Europe-wide banking supervisory body is set up, with leaders aiming for this to happen at the end of the year.

Another key measure agreed was that the bailout funds would be used "in a flexible and efficient manner in order to stabilise markets" - a reference to buying countries' bonds to drive down high borrowing costs that have crippled Spain and Italy.

"We took a good decision on growth," said German Chancellor Angela Merkel as she left the meeting. Merkel appeared to have dropped her insistence on recapitalisation funds to banks being channelled through governments but kept her demand that any such aid be combined with demands for reform of the financial sector.

€120 billion pledged to boost growth

EU leaders also agreed a package of measures worth some €120 billion they hope will bolster growth in the recession-hit bloc. They pledged to boost the capital of the European Investment Bank by €10 billion that should boost its overall lending capacity by €60 billion and help vulnerable countries fund economic expansion to "grow themselves out of the crisis."

Another €55 billion euros is to be scraped together from unused EU funds and earmarked for small- and medium-sized enterprises and youth employment schemes, the EU chief said.

Italian Prime Minister Mario Monti and his Spanish counterpart Mariano Rajoy had threatened to block a wider "growth pact" unless they won concession on short-term moves to drag their economies from the mire. This prompted one European diplomat to fume that Madrid and Rome were "holding the pact hostage."

The head of the eurogroup finance ministers, Luxembourg Prime Minister Jean-Claude Juncker, said that Italy and Spain dropped their resistance in return for the short-term measures to stabilise their economies.

A beaming Monti told reporters afterwards: "Everything is very important for the future of the EU and the euro zone. Italy is doubly satisfied." He acknowledged there were "some tensions" and said that he had to "put quite a bit of pressure" on other leaders to force through his wishes.

The summit, which continues later today, was being scrutinised both by jittery financial markets and world leaders, as the euro zone battles to solve its two and a half year debt crisis that has endangered the global economy.

In a longer-term perspective, EU leaders also agreed on a tentative "roadmap" for the future shape of the euro zone that could include a banking union and a budgetary union, Van Rompuy said. He said he would produce another report with a "specific and time-bound roadmap for the achievement of a genuine economic and monetary union" in October.

Leaders believe a revamped euro zone is essential to avoid a further crisis happening again.

Euro bank recapitalisation deal a 'good result' - Draghi

European Central Bank chief Mario Draghi today hailed as "a good result" a deal to recapitalise troubled euro zone banks via the forthcoming European Stability Mechanism rescue fund.

"The future possibility of using the ESM for direct capitalisation of the banks, which was something that the ECB had advocated for some time is another good result," of a two-day European Union summit, Draghi said.

ECB officials have long called for euro zone governments to take on a greater burden in providing emergency aid to troubled banks, after the central bank implemented exceptional measures that pose a growing risk to its own accounts.

In two so-called long-term refinancing operations (LTROs) in December and February, the central bank pumped more than €1 trillion into the banking system in a bid to avert a dangerous credit squeeze.

The ECB also intervened in sovereign debt markets in 2010 and 2011 under its controversial Securities Market Programme (SMP), buying up more than €200 billion of bonds to help bring down borrowing costs for heavily indebted countries.

The programme, seen by some as breaking in spirit rules prohibiting the ECB from underwriting government finances, has been dormant since February, but it still exists.