'Old Europe' tries to close ranks against Britain over treaty

The fallout from the two EU referendum "no" votes became a full-blown crisis yesterday after efforts by Germany to reform an alliance among the core members were blocked.

Amid continuing acrimony after the "no" votes in France and the Netherlands, Germany was heading diplomatic efforts to stop Tony Blair killing off the European constitution in all but name. At the same time Berlin and Paris backed new proposals to freeze, then reduce, the British budget rebate, a plan that could put Mr Blair on the defensive on two fronts.

Shellshocked by the "no" votes, there was an air of panic in several European capitals yesterday. The Italian welfare minister, Roberto Maroni, sparked a flurry on financial markets by suggesting that Italy should hold a referendum on abandoning the euro and returning to the lira - an idea rejected by more senior government figures.

Jean-Claude Juncker, the prime minister of Luxembourg, said he will quit if his country votes against the constitution next month. He also said that failure to agree on a new budget for the EU at a summit in two weeks would provoke a "big European crisis".

Meanwhile, the bad blood between capitals suggests a growing split, along the lines of the old/new European divide on Iraq. This time, the divide is likely to be over economic policy, the EU's future enlargement and further efforts to reform the EU's system of farm subsidies.

It emerged that Gerhard Schröder, the German Chancellor, had sought to convene all six founder members of the EU but the Dutch premier, Jan Peter Balkenende, and the Italian prime minister, Silvio Berlusconi refused.

Mr Balkenende argued that, to form a new grouping like that, would send a negative signal to other countries and not respect the spirit of the Dutch referendum which suggested a slow-down in integration.

German sources insisted the initiative was not designed to recreate a "core" or inner tier of Europe, but was linked instead to the push to continue with ratification of the constitution.

Berlin is the main beneficiary of the constitution because of the proposed change in the voting system. For the first time, it would link decision-making power to size of population - giving Germany the greatest say in EU decisions.

Desperate to keep the constitution alive, the German government is pointing to a declaration under which, if 20 nations, ratify the treaty, EU leaders must meet to decide what to do next. That could allow the constitution's supporters to put such pressure on the naysayers that they change their minds, or threaten to adopt the treaty with those that want it.

However, legally-speaking, all 25 nations must ratify the treaty for it to come into force and Mr Balkenende has already said he will not do so, after his country's "no" vote.

Mr Blair is demanding France and the Netherlands explain how the constitution could be ratified in their countries before it goes to a referendum in the UK.

He may be backed by other nations with referendums looming. The fear is that a domino effect could bring "no" votes in Denmark, Poland the Czech Republic and Ireland as well as the UK. Even in federalist Luxembourg, opponents of the treaty have hit 32 per cent in opinion polls.

Mr Schröder and the French president, Jacques Chirac, will try to deflect some domestic criticism by presenting Mr Blair as the obstacle to EU integration, when all 25 EU leaders meet in Brussels on 16 June.

The UK's refusal to hold a referendum in present circumstances will be coupled with British obduracy on another issue - the British budget rebate.

The 25 leaders are due to decide on a new financing package for the EU to run from 2007-2013 and Britain is isolated over its rebate, worth up to €5bn (£3.3bn) a year.

Latest drafts of the negotiating text call for curbs to the rebate "as a result of successive enlargements and the UK's relative prosperity to amongst the highest in the Union".

In 2007, the size of the rebate would "correspond to its nominal average" over the previous seven years - or €4.6bn - though it would then be set on a "downward path from the next year".

British sources have already rejected the idea of a phase-out. However, if that idea were removed, placing a ceiling on the rebate would be difficult to resist.

Meanwhile, the UK was also calling for further spending cuts, disputing claims that the latest proposal would limit expenditure to 1.06 per cent of gross national income. British officials say the proposal is not transparent and may be closer to 1.09 per cent.

Behind the scenes, some officials believe that Berlin and Paris may be manoeuvring to revive moves to create a two-tier EU. Eighteen months ago, when negotiations over the constitution collapsed, plans were circulated for a group of EU countries to press ahead with a "hard core".

Those ideas eventually came to nothing, mainly because there is no consensus on the areas upon which core countries could usefully co-operate.

EU officials believe that only a dramatic and bold initiative by France and Germany - perhaps to create a common fiscal or foreign policy - would make such an initiative worthwhile.

But neither Mr Schröder nor Jacques Chirac are in any position to launch a plan. Mr Schröder faces an election in the autumn which polls predict he will lose; M Chirac has been weakened since the "no" vote.