* Merkel, Hollande, Monti, Rajoy meet at 1200 GMT
* Meeting to pave way for key EU summit next week
* Italy, France, Spain seek more budget flexibility
* Monti needs results to stem popularity slide
* Wants euro rescue funds to buy government bonds
By Gavin Jones
ROME, June 22 (Reuters) - The leaders of Germany, France, Italy and Spain will try to find common ground in Rome on Friday to restore confidence in the euro zone ahead of a full EU summit next week, with German Chancellor Angela Merkel likely to be outnumbered.
Dangerously high borrowing costs for Spain and Italy have eased a little on market hopes for policy initiatives at the Brussels summit on June 28/29. If it falls short, both countries may be pushed closer to eventually needing sovereign bailouts.
Friday’s meeting will search for ways to achieve fiscal and banking union in the euro zone and, more urgently, it may also be the occasion for Spain to formally request assistance of up to 100 billion euros for its struggling banks.
An audit released on Thursday found Spanish banks would need up to 62 billion euros in extra capital to weather adverse circumstances.
Merkel is expected to resist any pressure from Monti, French President Francois Hollande and Spanish Prime Minister Mariano Rajoy for less stringent euro zone fiscal policies or the issuance of common euro zone bonds.
While Spain’s needs are most pressing - its medium term borrowing costs hit a euro era high at auction on Thursday - the political stakes may be higher for Italy’s unelected technocrat prime minister, Mario Monti.
With his popularity sinking, the parties that back Monti in parliament are increasingly reluctant to support his reform proposals at home, but demand he get results in the European arena to ease the pressure on Italy’s recession-bound economy.
“Monti knows he has to get his ducks in a row on the European side so he can tell the parties that he’s sorted that part out, and now it’s their turn to help sort out Italy,” said James Walston, politics professor at the American University in Rome.
“Friday’s summit is important for Monti in symbolic terms because it shows Italians that he is centre-stage.”
Though hugely popular when he came to office in November, his approval rating has halved as tax hikes and pension cuts exacerbated an already severe recession, and his labour reform estranged both unions and the business establishment.
But for the markets, Monti remains the man most likely to tackle Italy’s debt mountain and uncompetitiveness. If he comes under serious threat, Italy could quickly supplant Spain as the euro zone’s main flashpoint.
Monti’s hand was weakened by comments on Wednesday by his predecessor, Silvio Berlusconi, who said the prospect of Italy quitting the euro was “not blasphemy” and that he failed to understand why it would hurt Italy’s economy.
Berlusconi’s People of Freedom party is one of the two main groups that guarantee Monti a majority in parliament.
“The best that Monti and Rajoy will get from Merkel at this meeting is talk,” said Nicholas Spiro of Spiro Sovereign Strategy.
However, with 10-year Spanish bond yields having already fallen by more than 0.7 percentage points from recent highs, he said that ahead of next week’s summit even vaguely supportive comments from Merkel may be enough to underpin the market.
The two hour meeting will start at 1200 GMT. It will be followed by a joint news conference by the four leaders. No joint statement is expected.
Monti, who presents himself as a mediator between France and Germany, has insisted for months that the euro zone must temper the German-led austerity drive with measures to foster growth.
That position is shared by Hollande and Rajoy, but when the Italian leader has tried to transform his pro-growth rhetoric into policy prescriptions for the euro zone his ideas have generally met a cool response from Merkel.
He proposed on the sidelines of this week’s G20 summit using the euro zone’s rescue funds to buy the bonds of Spain and Italy in the secondary market to bring down their borrowing costs.
Monti will raise it again in Rome..
Spain’s Foreign Minister José Manuel Garcia-Margallo called the idea “intelligent”, but Merkel played down the plan, which investors said might be counter-productive unless the European Central Bank stepped in decisively in support.
Other proposals from Monti, such as stripping some forms of public investment from budget deficit calculations, or commonly issued euro zone bonds, are also broadly supported by France and Spain but opposed by Germany, at least for now.