German Chancellor Angela Merkel demanded stronger central powers for the European Union's executive to veto national budgets that breach EU rules, risking a clash with close ally France at a summit of the bloc's leaders on Thursday.

Addressing parliament in Berlin hours before the 22nd summit since the start of the euro zone's debt crisis, Merkel also sought to slow the race to create a single European banking supervisor, saying quality was more important than speed.

French President Francois Hollande took a very different tack in an interview with six European newspapers, warning that budget discipline alone would not solve the euro zone's problems without doing more to revive growth, and calling for greater haste in implementing a banking union.

Merkel skirted the issue of a possible credit line for Spain, which euro zone officials expect Madrid to request within weeks, but reiterated her desire to keep Greece in the currency area despite its chronic debt problems.

In Greece, workers walked off the job for the second time in three weeks, aiming to show EU leaders that a new wave of wage and pension cuts will only worsen their plight after five years of recession.

"We have made good progress on strengthening fiscal discipline with the fiscal pact but we are of the opinion, and I speak for the whole German government on this, that we could go a step further by giving Europe real rights of intervention in national budgets," Merkel told the Bundestag lower house.

A proposal by German Finance Minister Wolfgang Schaeuble to create a super-empowered European currency commissioner was a possible way forward, she said, and more European control should be accompanied by a stronger European Parliament.

Such moves would require EU treaty changes which Hollande is keen to avoid. He recalled that French and Dutch voters had rejected a previous attempt to tinker with EU institutions in referendums on a European constitutional treaty in 2005.

French Budget Minister Jerome Cahuzac told BFM TV that if the German budget czar idea required giving away more national power to Brussels, "the president has made his position clear in refusing to alter the (French) constitution ... because Francois Hollande has not accepted a new transfer of sovereignty".

Merkel also advocated the creation of a European fund to invest in specific projects in member states which she said could be fuelled by a financial transaction tax which 11 euro zonecountries have said they will adopt.

Her call echoed a proposal by the heads of four EU institutions for the 17-member euro zone to have its own budget - known in EU jargon as a "fiscal capacity" - on top of the 27-nation union's common budget, which mostly funds agriculture and aid to poorer regions.

"FISCAL CAPACITY"

A note circulated by European Council President Herman Van Rompuy, who will chair the summit, and seen by Reuters said the new pot of money would provide a way of insuring countries against economic shocks, and of supporting structural economic reforms when a member state made a contractual commitment.

"Every member state, regardless of their income levels, would over time contribute to the fiscal capacity and then benefit from its support," Van Rompuy wrote. "Therefore, this would not lead to permanent transfers across countries."

Decisions on such reforms are not expected until a December summit, and Merkel's demands appeared to be partly an attempt to shift the agenda from focusing on moves towards a banking union, which have drawn fierce criticism in Germany.

Since the European Central Bank announced last month that it was prepared to buy the bonds of struggling euro zone countries in unlimited amounts under strict conditions, government borrowing costs have fallen sharply and some of the market-led pressure to move rapidly to resolve the crisis has dissipated.

Spain's 10-year bond yields sank to their lowest since February at an auction on Thursday at which it sold 4.61 billion euros of government debt, helped by Moody's decision this week to maintain its credit rating at investment grade.

But rather than signaling that Madrid does not need help, Moody's verdict was predicated on Spain soon applying for a euro zone assistance programme to trigger ECB intervention.

"In many senses, it's a very false market because it's not really telling you (whether) people feel comfortable about the outlook for Spain," said Marc Ostwald, a strategist at Monument Securities in London.

Germany has said Prime Minister Mariano Rajoy is taking all the right measures to overcome fiscal woes caused by a banking crisis after a real estate bubble burst, but officials say Berlin's resistance to a credit line for Spain is waning.

The first aim on the banking union proposal, backed by leaders at the last summit in June, is to create a single banking supervisor under the ECB, but the original goal of having the legislation in place by January 2013 already looks in doubt, and it may not be fully up and running until 2014.

Joerg Asmussen, Germany's representative on the ECB's executive board, said on Wednesday the central bank would not be ready to start overseeing banks from early next year, even if the legal structures are in place by then, and said it was more important to do it properly than to do it quickly.

The latest draft summit conclusions obtained by Reuters said only that a single supervisor was a "matter of priority" and leaders should have the "objective of completing it by the end of the year".

A senior EU official said that if that wording survived until the end of the summit "it will give a very strong impetus to the integrated financial framework".

But the deeper the discussion on banking union goes, the more complex and problematic it gets. As well as disagreement over the timeline for a single supervisor - a prerequisite for the euro zone's rescue mechanism to be able to recapitalize banks directly - there are disputes about how it will function.

Countries outside the euro zone - particularly Britain, which has Europe's biggest banking sector - are concerned their banks could be disadvantaged if no balance is maintained between the ECB and its oversight of euro zone banks and the powers of other authorities to oversee non-euro zone banks.

And if non-euro zone countries join the banking union, as policymakers are hoping, it is unclear what representation they would then have within the ECB, since the central bank is currently answerable only to euro zone member states.

Those complications will not be ironed out this week and may not be resolved for months to come, making it all the more unlikely that the legal structures to establish a single supervisor will be ready by January next year.