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 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.
Addressing parliament in Berlin hours before the 22nd summit since the start of the eurozone's debt crisis, Merkel sought to slow the race to create a single European banking supervisor, saying quality was more important than speed.
Germany, reluctant to see its politically sensitive regional Landesbanks and savings banks come under outside supervision, insists European oversight should only cover big cross-border banks, and rejects any joint deposit guarantee which could see richer countries prop up the banks in their poorer counterparts.
Hollande told reporters at a preparatory gathering of Socialist leaders: "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."
Merkel and Hollande are expected to hold a one-on-one meeting before the summit proper begins, EU officials said, which may provide a chance to discuss their differences.
Merkel skirted the issue of a possible credit line for Spain, which eurozone 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.
French Budget Minister Jerome Cahuzac told BFM TV that if the German budget tsar idea required giving away more national power to Brussels, "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 eurozone countries have said they will adopt.
Her call echoed a proposal for the 17-member eurozone 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.
A note circulated by European Council President Herman Van Rompuy, who will chair the summit, said the new pot of money could provide countries with insurance against economic shocks, and support structural reforms.
"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 to EU leaders in a note seen by Reuters. "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 away from 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 eurozone 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 eurozone assistance program 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 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 very 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 eurozone's rescue mechanism to be able to recapitalize banks directly — there are disputes about how it will function.
Countries outside the eurozone — 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 eurozone banks and the powers of other authorities to oversee non-eurozone banks.
And if non-eurozone 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 eurozone 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.
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