Conflicting signals: is euro zone destined to shrink?

European Union officials say that France and Germany had held consultations "at all levels" about forming a more integrated and possibly smaller euro zone.

European Union officials in Brussels told the Reuters news agency that France and Germany had held consultations "at all levels" about forming a more integrated and possibly smaller euro zone.

The report came as the European Commission gave warning that the single-currency zone is at risk of a "deep, prolonged" recession. "Growth has stalled in Europe and there is a risk of a new recession," said Olli Rehn, the commission's vice president for economic and monetary affairs.

Speculation about preliminary discussions on reshaping the zone persisted even after the parliamentary finance spokesman for the Christian Democratic Union of the chancellor, Angela Merkel, insisted that Germany would resist any move to restrict membership to the stronger economies.

"Such a shrinking process would be deadly for Germany because we would end up in a mini-euro zone with all the effects you can see in Switzerland," Michael Meister told Bloomberg News.

"It would be a deadly development for an export country like Germany. It can't be in our interest at all and if it's not in our interest, we should do everything to keep it from happening."

France also challenged the report, a finance ministry spokesman claiming there was no project in the works to reduce the membership of the euro bloc.

However, one official quoted by Reuters talked of changes being discussed on an "intellectual" level without having advanced to operational or technical discussions. Commentators pointed out that this was not at odds with comments by the French president, Nicolas Sarkozy, in recent days that a two-speed Europe, with the euro zone moving ahead more swiftly than all 27 EU nations, was the only model for the future.

The official, not identified because of the sensitivity of the issue, said: "We need to move very cautiously, but the truth is that we need to establish exactly the list of those who don't want to be part of the club and those who simply cannot be part."

With different officials giving contradictory messages, the scope for confusion is plain. Despite the denials, one senior German government official reportedly supported the idea as a case of trimming the euro zone to make it stronger: "You'll still call it the euro, but it will be fewer countries."

Meanwhile, in one positive sign on a day dominate by gloom, moves towards unity governments in Italy and Greece appeared to have steadied the financial markets.

Days of delicate negotiations ended with the naming of Lucas Papademos, a former vice president of the European Central Bank, as the new prime minister of Greece.

A committed champion of Greece's place within the EU, he will head an interim government tasked with meeting stringent conditions attached to the latest European bailout, which had been thrown into jeopardy by his predecessor George Papandreou's unexpected plan - later scrapped - to hold a referendum on the package.

In Rome, any hope on Prime Minister Silvio Berlusconi's part that his promise to resign once reforms were passed would ease the national crisis had evaporated amid soaring interest rates on Italian 10-year bonds. Although the yield fell back to around seven per cent, this remains the level at which Portugal, Greece and the Irish Republic were forced to approach Brussels cap in hand.

But the pressure seems to have persuaded Mr Berlusconi to abandon his previous intention to call a general election.

Aides said he was now convinced this would be unwise and was instead considering a national unity government headed by a former European Commissioner, Mario Monti.

Mr Monti, an economist, would win the support of the centre-left opposition though not Mr Berlusconi's present coalition partner, the Northern League.

Reports that a possible break-up of the euro zone had at least been mooted surfaced as political and financial leaders came to terms with the threat of contagion, with the debt crisis trundling unimpeded through Europe and political leaders being accused of dithering.

The British prime minister, David Cameron, defying Mr Sarkozy's pointed suggestion last week that he had "missed a good opportunity to shut up" about a currency zone to which his country did not belong, sent strong signals that the European Central Bank should be ready to step in to aid Italy.

Germany opposes this approach even though Italy's debts are so great - at €1.9 trillion (Dh9.47 trillion) - that they swamp the total fund set aside in the zone's financial stability contingency facility (EFSF). The rescue fund currently holds €440 billion in the rescue fund but officials said there were no plans to divert any of this to Rome.

Mr Cameron told a trade and investment conference in London: "Italy is the third largest country in the euro zone. Its current state is a clear and present danger to the euro zone and the moment of truth is approaching. If the leaders of the euro zone want to save their currency then they - together with the institutions of the euro zone - must act now. The longer the delay, the greater the danger."

In Brussels, the European Commission announced what it admitted was further bleak economic news, cutting its growth forecast for the euro zone for next year from 1.8 per cent to 0.5 per cent. It sees 2011 growth marginally down from 1.6 per cent to 1.5 per cent, and acknowledges that there is now a risk of a new recession.