BRUSSELS (Reuters) - With the pressure off after finance ministers clinched a significant agreement on a single banking supervisor, European Union leaders differed widely at a summit on Thursday over the next steps for their troubled currency union.
Before tucking into marinated salmon with fromage blanc and pan-fried turbot with boiled pumpkin, the 27 leaders argued along well-worn lines over banking resolution, deficit reduction and a common euro zone budget, making little headway.
North European creditor nations led by German Chancellor Angela Merkel sought to lay down new red lines to prevent a deal that made the European Central Bank the euro zone's top banking supervisor from leading to new liabilities for their taxpayers.
Merkel told the German parliament before travelling to the summit that Berlin would continue to reject any mutualisation of the debts of either euro zone countries or their banks.
A German delegation source said that in the summit room, she opposed a joint resolution fund for banks at this stage and rejected any big "fiscal capacity" to help euro zone states cope with economic shocks or reward them for structural reforms.
Instead, she said EU countries should concentrate on consolidating their own budgets, according to notes of the meeting and an account provided by one participant.
Merkel was irritated by European Council President Herman Van Rompuy's proposals for a three-stage drive towards greater fiscal, economic and political union, saying he had gone too far without consulting member states, the source said.
"When we talk about the function of shock absorption, we are talking about 80-100 billion euros - where do we get that from?" one participant quoted Merkel as saying.
French President Francois Hollande called for financial incentives for euro zone countries to undertake reforms and backed an Italian suggestion to loosen the way the EU calculates budget deficits by exempting public investment.
The leaders of Spain and Italy, the two big southern states fighting to retain market access and overcome a recession deepened by austerity measures, pressed for more generous euro zone funding to reward economic reforms.
Van Rompuy, chairing the summit, warned the leaders against complacency, saying: "We have a currency that is a first class reserve currency and an economic and monetary union that is second-class. As long as we don't fix this we are vulnerable."
A diplomat reporting from the chamber said Van Rompuy told the heads of state and government that a single banking supervisor would be ineffective if there was not rapid agreement on a mechanism for resolving failing banks.
European Central Bank President Mario Draghi urged the leaders to speed up reforms of labor markets, pension and welfare systems and liberalize services, without easing fiscal discipline.
"If in this context the world sees that governments loosen policy, we will quickly lose credibility," he was quoted as saying.
Non-euro states led by Britain and Poland appealed to the euro zone leaders to focus on preserving and completing the European single market and avoiding initiatives that would increase the divide between euro "ins" and "outs".
British Prime Minister David Cameron said London wanted to help the euro zone move forward in integration but there must be flexibility for other members who did not wish to join the euro.
Additional reporting by Mark John; Writing by Paul Taylor; editing by Luke Baker