Germany and France, Europe's two central powers, clashed over greater European Union control of national budgets and moves towards a single banking supervisor before a summit of the bloc's leaders began on Thursday.
German Chancellor Angela Merkel demanded stronger authority for the executive European Commission to veto national budgets that breach EU rules, but French President Francois Hollande said the issue was not on the summit agenda and the priority was to get moving on a European banking union.
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The two leaders met privately for 30 minutes just before the start of the 22nd EU summit since the euro zone's debt crisis erupted nearly three years ago. Afterwards, a French source said they had agreed on the need for a tight timetable for introducing banking union.
Addressing parliament in Berlin earlier, Merkel sought to slow the race to create a single European banking supervisor, saying quality was more important than speed.
Reluctant to see its politically sensitive regional Landesbanks and savings banks come under outside supervision, Germany says European oversight should cover big cross-border banks only, and rejects any joint deposit guarantee under which richer countries might underwrite banks in poorer counterparts.
Hollande told reporters: "The topic of this summit is not the fiscal union but the banking union, so the only decision that will be taken is to set up a banking union by the end of the year and especially the banking supervision.
Asked why he thought Merkel was dragging her feet, Hollande said it could be related to Germany's electoral calendar, with elections due in September 2013, adding that the two dominant EU powers had a duty to solve the crisis.
In Greece, police clashed with protesters hurling stones and petrol bombs during a general strike that brought much of the near-bankrupt country to a standstill.
In her speech to parliament, 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 chronic debt problems.
"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 called for a stronger European Parliament. Such moves would require EU treaty changes, which Hollande is keen to avoid.
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 zone countries have said they will adopt.
Her call echoed a proposal 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.
In a plea for unity at the start of the summit, European Council President Herman Van Rompuy said last week's award of the Nobel Peace Prize to the EU should inspire leaders to work together for peace and prosperity.
A note circulated by Van Rompuy to leaders said the proposed new pot of money could provide euro zone countries with insurance against economic shocks and support those that committed themselves contractually to structural reforms.
"Every member state, regardless of their income levels, would over time contribute," Van Rompuy wrote to EU leaders in a note seen by Reuters. "Therefore, this would not lead to permanent transfers across countries."
Several countries, including the Netherlands, Finland and Austria, voiced suspicion of the idea, although none rejected it outright.
European Parliament President Martin Schulz, in an address to the summit, warned the leaders against proposals which he said "threaten to drive a wedge through our union".
"Above all, there is no need whatsoever to create new, parallel unions and new, parallel institutions," he said.
Decisions on institutional reforms are not expected until a December summit, and Merkel's demands appeared to be partly an attempt to shift the focus away from moves towards a banking union, which have drawn fierce criticism in Germany.
SENSE OF URGENCY FADING?
Since the European Central Bank said last month it was ready to buy the bonds of struggling euro zone states in unlimited amounts, state borrowing costs have fallen sharply and some of the 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, helped by Moody's decision this week to leave its credit rating at investment grade.
But rather than signaling that Madrid does not need help, Moody's verdict was predicated on Spain applying soon 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, strategist at Monument Securities in London.
The leaders agreed at their last summit in June to create a single banking supervisor under the ECB, but the original goal of having legislation in place by January 2013 already looks in doubt, and it may not be fully up and running until 2014.
EU Economic and Monetary Affairs Commissioner Olli Rehn said it was important the summit maintain the momentum on banking union "which is critical to break the vicious circle between sovereigns and banks".
Joerg Asmussen, the German member of the ECB's executive board, said on Wednesday the central bank would not be ready to start overseeing banks from early next year, and said it was more important to do it properly than to do it quickly.
The latest draft summit conclusions 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".
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.
(Additional reporting by Stephen Brown and Madeline Chambers in Berlin, Jan Strupczewski and Luke Baker in Brussels, Harry Papachristou and Lefteris Papadimas in Athens and Gilbert Krijger in Amsterdam. Writing by Paul Taylor, editing by Mike Peacock)