Merkel and Hollande in crucial talks ahead of EU summit

Following turbulent start to their relationship, leaders must set aside differences in the search for the euro zone's financial crisis.

Marseille, France // Amid continuing gloom in the euro zone, its two most powerful political leaders, the German chancellor, Angela Merkel, and French president, François Hollande, meet in Paris today for crucial talks ahead of tomorrow's European Union summit.

Following the turbulent start to their relationship since Mr Hollande's election on May 6, they must try to set aside differences in the search for solutions to the zone's debt crisis.

The build-up to the two-day Brussels summit has hardly inspired optimism. Spain and Cyprus have asked for bailouts; 28 Spanish banks have suffered a mass downgrading by the Moody's credit rating agency and trading on the single currency has been nervy.

Financial analysts have expressed uncertainty about the possible outcome of the meeting, given the differing approaches adopted by leaders of the hitherto more united Franco-German axis.

Mrs Merkel moved firmly this week to reaffirm her opposition to the idea of Eurobonds, seen by Mr Hollande as a way of pooling the sovereign debt of all countries tied to the single currency.

Describing such a policy as "economically wrong and counterproductive", the chancellor said: "When I think of the summit, I feel concerned that yet again we will have too much focus on all kinds of ways of sharing debt."

Mrs Merkel, who has made no secret of her irritation with the new French president's mantra of "growth not austerity", has also been reminding European partners that Germany remains the motor for economic stimulus.

On the other hand, her own finance ministry is said in leaked analysis to have warned that the euro's collapse would be devastating for Germany. One leading German newspaper, Sueddeutsche, says the choice is between bad solutions and catastrophe.

Faced with the risk of the German economy being reduced by as much as 10 per cent in the event of single currency failure, a finance ministry official told the news magazine Der Spiegel: ""When measured against such scenarios, even an extremely costly rescue seems to be the lesser evil."

Cyprus's request for European aid, which it blamed on side-effects of the crisis in the Greek financial sector, will remind summit leaders of the gravity of their collective malaise.

But whatever reservations certain member states have with the remedies proposed by the new socialist administration in France, Germany's reluctance to shoulder the effects of propping up failed economies is worrying some financial analysts.

"Investors want to see what direction the summit's outcome will point to," Hirokazu Yuihama, a senior strategist at Daiwa Securities, told Reuters. "It's very unclear what specific agreements may actually be made."

The International Monetary Fund agrees with the European Commission, France and Italy in seeking what the EU competition commissioner, Joaquin Almunia, has called the "gradual mutualisation" of debt. He says it is the only means left to "stop the contagion".

Meanwhile, Spain has now submitted a formal application to the EU for a bailout - up to €100 million (Dh458.5 million), according to reports - of its banking sector.

With Greece still in turmoil and 19 similar EU summits having failed to produce a lasting cure to an economic crisis dating from 2010, there are no great hopes that this week's Brussels gathering can work miracles.

Mr Hollande has won one significant battle in the euro debate, persuading the third and fourth single currency economies, Italy and Spain, and also Mrs Merkel of the merits of a €130 billion growth plan, with the emphasis on job creation.

A draft plan to be put before the summit tomorrow and Friday would move towards meeting German objectives of closer fiscal and banking union.

But Germany also wants strict controls on national budgets within the zone.

The French daily newspaper Le Figaro said that while the word "federalism" was not being mentioned, this - the creation of a single budgetary power - is what the draft document seemed to be advocating.

The document is signed by Europe's "four sages": Herman Van Rompuy, president of the European Council, José Manuel Barroso, president of the European Commission, Mario Draghi, president of the European Central Bank, and Luxembourg's Jean-Claude Juncker, president of the Euro Group and the EU's longest-serving head of government.

They accept that political reforms would have to come later as European integration "necessarily requires a more solid democratic foundation and the broad support of public opinion".

In Britain, outside the zone but vulnerable to serious consequences should it crumble, a charity is offering a £250,000 (Dh1.43 billion) prize for the best plan for managing break-up. The organisers of the Wolfson Economics Prize have already whittled down ideas to a short list of five and will announce the winner on July 5.

The shortlisted entries cover possible responses to Greece abandoning the euro; a suggestion that Germany should mastermind a top-secret contingency plan for all 17-member states to revert to their own currencies simultaneously and the "orderly" division of the single currency area into two or more regions.

One contender, Jonathan Tepper, from the global research firm Variant Perception says: "Exiting from the euro and devaluing would be very painful, but the pain would be short and sharp." He argues that while many economists expect catastrophic consequences if any country leaves the zone, 69 nations have departed from currencies in the past century with "little downward economic volatility".

With additional reporting by Reuters