Credit crunch puts new strains on Sarkozy-Merkel ties

By Francois Murphy and Kerstin Gehmlich - Analysis

PARIS/BERLIN (Reuters) - French President Nicolas Sarkozy and German Chancellor Angela Merkel have bickered over the euro, argued about a Mediterranean union and now the global financial crisis is reopening old wounds between them.

There had been few public spats since France took over the European Union presidency in July, and they cooperated well over Sarkozy's first big test at the EU's helm, Russia's brief war with Georgia in August.

But now the pair have clashed over how to deal with the credit crisis, and Europe's traditional "Franco-German motor" seems to be sputtering just when leaders across the 27-nation bloc are calling for united action to stop the rot.

"The relationship between the two leaders is not spontaneously good. They are making enormous efforts on both sides but it is a difficult relationship," said Dominique Moisi, special adviser to the French think-tank IFRI.

Sarkozy and Merkel are due to hold a regular Franco-German meeting in late French President Charles de Gaulle's home town on Saturday, days before a summit of EU leaders that will examine overhauling the Union's financial regulation.

Germans were furious last week when Economy Minister Christine Lagarde made public a French proposal to establish an EU-wide rescue fund to help troubled banks.

Government sources say senior officials in the German Finance Ministry and Chancellery had made clear their opposition to the fund, which was to total 300 billion euros ($411.7 billion), in private talks with French officials.

When Lagarde went ahead anyway and announced the French plans in an interview with German newspaper Handelsblatt three days before a Paris summit of European G8 leaders, irate German Finance Minister Peer Steinbrueck moved swiftly to torpedo it.

The French then backpedalled, with both Lagarde and an adviser to Sarkozy denying the 300-billion euro fund plan ever existed. Top German officials say this was wrong.

The Paris summit of leaders of the Group of Eight powers that followed produced a pledge to shore up banks, protect savers and regulate markets but fell short of the strong pan-European measures France had been pushing for.

DIFFERENCES OVER HANDLING OF CRISIS

A joint Franco-German crisis strategy on the financial crisis appears elusive.

Ireland drew criticism from other EU states in announcing its own bank deposit guarantee plan last week. But several other states have since taken their own measures on banks, including Germany, undermining Sarkozy's calls for the bloc to unite.

"The problem is that there is not a sufficiently close relationship between France and Germany to compensate for the disagreements among the rest (of the EU)," Moisi said.

"The irresistible 'every man for himself' approach in Europe is no longer compensated for by a perfect Franco-German core."