UPDATE 3-With Europe on edge, France and Germany squabble

Fri Jun 15, 2012 2:45pm EDT

* France and Germany trade barbs as euro crisis deteriorates

* Merkel criticises French economy after jibes from Paris

* Hollande and Merkel on collision course over euro crisis

By Annika Breidthardt and Daniel Flynn

BERLIN/PARIS, June 15 (Reuters) - Germany's Angela Merkel criticised France's economic performance on Friday in a war of words with its new Socialist president, Francois Hollande, over how to tackle Europe's deepening debt crisis ahead of a pivotal election in Greece.

Describing her own country as Europe's "stabilising anchor and growth engine", the centre-right chancellor told German business leaders that Europe should talk about the growing gap between the bloc's two biggest economies.

The unusual rhetoric came after Hollande met German centre-left opposition leaders this week and also unveiled economic reforms, including a partial lowering of the pension age, that Berlin fears will only deepen France's economic problems.

The rift between the two powers that traditionally drive European Union policy coul hardly come at a worse time. If a radical left party wins Sunday's vote in Greece, the euro zone could find itself scrambling to avert a humiliating break-up.

Merkel said in her speech that only a decade ago Germany trailed or was at best even with France by traditional measures of competitiveness, such as unit labour costs.

Now, she said, Germany had opened up a "growing" lead, saying this was an issue "that must be discussed in Europe, naturally".

Tensions have risen so much that French Prime Minister Jean-Marc Ayrault felt moved to deny that his country was trying to form a united front with Italy and Spain against Merkel and her drive for austerity in the single currency zone.

But France later sought to cool tempers, saying relations with Germany were intact after Hollande and Merkel found common ground on G20 issues during a video-conference with other EU leaders.

"There is a free exchange of views, which is not the same as aggressiveness. We don't perceive it that way at all," said a French presidential source.

Still, the spat bore out fears voiced after Hollande's election last month that the Franco-German partnership may not be as close as under his predecessor, Nicolas Sarkozy, whom Merkel backed during the campaign, refusing to meet Hollande.

Sarkozy's conservative UMP, now in opposition, accused Hollande's Socialists of feeling "obliged to sabotage" the Paris-Berlin dialogue because they disagreed with Merkel.

UMP national secretary Camille Bedin criticised Ayrault for advising Merkel to "take things seriously and courageously" and Industry Minister Arnaud Montebourg for saying Merkel's "ideological blindness" was to blame for having "driven seven countries out of the euro zone's 17 into recession".

In addition to the pensions move, Hollande's government has announced plans to increase the cost of laying off workers.

FRANCO-GERMAN POKER

Merkel reiterated her view that issuing new debt to finance growth was not sustainable and again ruled out mutualising euro zone debt or issuing joint bonds to tackle the crisis - a stance diametrically opposed to Hollande's.

Rebuffing international pressure on Germany to underwrite the debts or bank deposits of weaker euro zone economies, Merkel said this week that "Germany's strength is not infinite".

Hollande says Europe must do more to revive growth to offset its German-inspired focus on tackling deficits and public debt.

His positions are shared by Germany's centre-left Social Democrats (SPD) and Greens, who have been emboldened by his victory to step up their opposition to Merkel ahead of next year's federal elections, where she will seek a third term.

SPD leader Sigmar Gabriel said after meeting Hollande and Ayrault in Paris on Wednesday there was "no crucial point" on which his party and the French government disagreed, including the need for a tax on financial transactions in Europe.

The meeting at the Elysee Palace with the SPD's three main leaders was in itself a breach of protocol as a new president would normally play host to the German chancellor before there was any question of meeting the opposition.

Hollande could have been paying Merkel back for her refusal to meet him when he was running against Sarkozy, but it was also seen as emphasising his rejection of the policy ideas of the "Merkozy" power couple that dominated the euro zone.

"It's all part of the big poker game taking place between France and Germany at the moment," said political analyst Jacques Reland of the London-based Global Policy Institute.

France's first Socialist president in 17 years is on track to secure a clear parliamentary majority on Sunday, adding the lower house to its control of the Senate, which would give the left more power than it has ever held in France.

At an EU summit on June 28-29, Hollande is seeking German agreement to implement growth- and job-creating measures to accompany the fiscal pact, which both the French and German parliaments have yet to ratify.

Merkel has accepted, with varying degrees of enthusiasm, four measures pushed by Hollande that were already on the agenda before his election: more capital for the European Investment Bank, reallocation of EU regional aid funds, project bonds to fund infrastructure, and the transaction tax.