Fault line undermines fragile euro

The French refusal yesterday to accept Europe's agreed priorities for the single currency is the most concrete evidence yet of the dangerous fault line which runs under the euro's fragile foundations.

Hurried attempts were last night being launched to patch over rift, but the question remains: could the divisions exposed yesterday re-emerge and push the project off course?

The risk of rupture over the design of economic and monetary union (Emu) has always been highest between France and Germany, where differences in the philosophy of the euro-zone run deep.

Germany has consistently demanded that, in return for its willingness to give up a strong mark, other member states must accept the stiffest rules of fiscal discipline, in order to give the euro the best chance of being as strong as the mark.

Only by demonstrating that other member states are prepared to accept German-style monetary discipline could Helmut Kohl, the German Chancellor, hope to persuade the German people that it was safe to sacrifice their currency.

The Maastricht rules for the euro are set, largely to German standards. And in November 1995, Theo Waigel, the German Finance Minister, underpinned Maastricht by proposing a "stability pact" which would ensure that countries joining Emu would maintain the same discipline after the 1999 launch.

As long as the Gaullists remained in power in France, Germany has, largely, been able to have its way over the design of the Emu rule-book.

Jacques Chirac, the French President, has always sought ways to soften Germany's monetary rigour, and has backed some form of political government to counter control by the future European Central Bank.

Germany's own difficulties in meeting the Maastricht criteria, seen most notably during the recent debacle over plans to re-value German gold, have strengthened the case for a more "flexible" approach to the Maastricht criteria.

The victory of the French Socialists, however, was always sure to bring France into a head-on confrontation with Germany over the Maastricht rules and the terms of the stability pact.

During the French election campaign, Lionel Jospin, the new Prime Minister, made clear that he would refuse to implement the austerity measures demanded by the Maastricht rules, thereby clearly opening the door to the "soft euro" which Bonn has hitherto abhorred.

Mr Jospin promised to create 700,000 French jobs and to reduce the working week to 35 hours, raising questions about whether France would have any chance at all of meeting the Maastricht deficit criteria under socialist rule.

On the campaign trail, Mr Jospin also condemned the entire stability pact as "absurd", suggesting he would seek to throw out the entire set of rules should he come to power. However, a senior European minister confirmed yesterday that Mr Jospin had privately appealed for a "form of words" on Emu which would enable him to keep France on track for the launch, while demonstrating to French voters that he had not betrayed them just one week after his victory.

And some observers saw yesterday's announcement from Dominique Strauss- Kahn, the new French Finance Minister, that the terms of the pact had to be re-worked, as a climb-down from the hard line struck by his party during the campaign.

Nevertheless, France's adamant refusal to accept the stability pact terms yesterday, has broken a taboo. To date, no member state - other than Britain - has taken such a strong stance against any elements of Emu architecture.

Whatever magic is now performed by the Dutch presidency, ahead of next week's Amsterdam summit, no "form of words" will be enough to accommodate French demands for establishing a political counter-weight to the European Central Bank. Such an initiative will demand weeks or months of bruising negotiation, rather than days.

Germany was cautious in its first response to French demands yesterday. But it seems highly unlikely that Bonn will be able to swallow any further weakening of its prized Maastricht rules or stability pact. Patching over yesterday's row will not heal the rift.