PARIS (Reuters) - A Franco-German deal to strengthen the euro zone has ended months of bickering between Paris and Berlin and raised the onus on French President Francois Hollande to embark on potentially explosive social and economic reforms.
German Chancellor Angela Merkel, Europe's most powerful politician, made a string of symbolic concessions to France in joint proposals for closer economic policy coordination outlined last week, in return for a clear commitment to reform.
She did so because bolstering the stagnant French economy has become a top German priority.
"If France weakens further, it endangers the foundations of the euro," a senior German official said.
Departing from past positions, Merkel accepted a full-time president of the Eurogroup of euro area finance ministers, more frequent summits of euro zone leaders, greater coordination of social and tax policy, a slowdown in the pace of deficit reduction and a commitment to reciprocity in EU external trade.
Furthermore, she cleared the way for the next stage of a European banking union by accepting a "resolution board" that will be empowered to take decisions on restructuring or winding up failed banks, financed by contributions from the banking sector and backstopped by the euro zone's rescue fund.
And she accepted all this could happen without treaty change and without transferring new powers to the executive European Commission.
"The Germans were so worried by the weakness of France that they have revised their strategy and decided they have to help France," said Jean-Dominique Giuliani, president of the pro-European Robert Schuman Foundation in Paris.
"On paper, Merkel made a lot of concessions to France, but by doing so she has given Hollande the face-saving political cover he needs to move ahead with reforms that are extremely sensitive, especially for the left," he said.
The Socialist president promised to use the extra two-year leeway for reducing France's budget deficit granted by EU authorities to reform the pension system, welfare benefits and tax breaks in negotiation with unions and employers.
Whether a Franco-German deal on Europe will make it easier for Hollande to overcome resistance to entitlement reforms from organized labor, the left and the street remains to be seen.
By ruling out new powers for Brussels or an early drive for European fiscal union that would require a new EU treaty, the conservative Merkel may also have changed tack for domestic reasons ahead of September's German general election.
Berlin officials now acknowledge there is almost as little enthusiasm in Germany as in France for ceding sovereignty over national budgets to the Commission, and no appetite for treaty change among euro zone partners.
Moving forward pragmatically through inter-governmental cooperation is hence more realistic and offers a way to skirt a potential British veto on any treaty amendment as London seeks to force a return of EU powers to national capitals.
"There is real convergence between France and Germany on the need to give structure to this governance - which is relatively new," said a diplomatic source in Hollande's office.
Berlin long suspected France of raising the subject only to try and exert influence on the European Central Bank, while Paris suspected Berlin of pushing a federalist agenda, he said.
Merkel's gesture to Hollande was preceded by a spate of German visitors - including Foreign Minister Guido Westerwelle, Economics Minister Philipp Roesler and Bundesbank President Jens Weidmann - who delivered the same message: Germany needs a strong France and does not want to lead Europe on its own.
Alarm at France's accelerating loss of economic competitiveness, expressed bluntly in private, finds public expression in statements by German policymakers that they are confident France will make the necessary reforms.
As the Germans see it, Hollande understands what reforms are necessary but has to convince a domestic audience that is under the false impression that enough has already been done.
Merkel's Paris concessions reflect a strong desire to avoid being seen as the sole driver of unpopular austerity policies. In the same vein, Germany has launched bilateral initiatives with Portugal, Spain and Italy to help overcome high youth unemployment.
The European Commission, relieved to see the main motor of European integration spring back into life after stalling during Hollande's first year in office, welcomed the Franco-German paper as giving momentum to its own blueprint for pulling Europe out of crisis.
"Many of the ideas mentioned in this contribution from France and Germany indeed reflect existing Commission proposals," Commission spokeswoman Pia Ahrenkilde-Hansen said.
Brussels was particularly pleased to see Berlin and Paris break a deadlock on a joint banking resolution mechanism ahead of this month's EU summit, which is due to approve detailed plans for a single European banking supervisor from 2014.
Euro zone policymakers see incremental progress towards a banking union as the best way to strengthen the currency area and rebut criticism that Europe has gone back to slow-motion business as usual now that bond market pressure has eased.
Ahrenkilde-Hansen was less enthusiastic about the idea of giving the Eurogroup a permanent head and secretariat, which would likely rival the Commission's own role over time, saying it was the not the first time such proposals had been made.
For Hollande, being seen to stand up to Brussels is a political precondition for pressing ahead with unpopular reforms of pensions, welfare benefits and labor markets, French officials say.
That may explain an uncharacteristic outburst in response to the Commission's economic policy recommendations last week, in which he said the EU executive could not "dictate" to France how it went about reforms.
The president faces resistance from within his own Socialist Party at a June 15-16 conference, as well as on the hard left from firebrand presidential contender Jean-Luc Melenchon, Communists, Trotskyists and trade unions.
He also has to guard against losing more working class votes to the far-right National Front, which advocates dumping the euro, leaving the European Union and closing French borders to immigrants and some imports.
Leftists were angered by his praise for former German Chancellor Gerhard Schroeder's tough welfare reforms in a speech at the Social Democratic Party's 150th anniversary congress in Leipzig last month.
"The Schroeder speech hurt Socialists subconsciously," said Marie-Noelle Lienemann, a left-wing Socialist critic of European economic policies. "But we are not here to judge Francois Hollande; our job is to apply political pressure so that the president hears us and acts."
Additional reporting by Noah Barkin in Berlin, Luke Baker in Brussels and Julien Ponthus in Paris; Writing by Paul Taylor; Editing by Will Waterman