UK policy upheaval over eurozone crisis

Mr Osborne has recognised the unusual nature of his eurozone stance

The crisis in the eurozone is turning UK policy towards Europe on its head.

Chancellor of the Exchequer George Osborne, in an article in the Financial Times, is not just urging eurozone leaders to "get a grip", he is also telling them that fiscal union is "necessary". He recognised that a Conservative chancellor urging closer European integration was a huge change of direction.

It is testimony to the fear stalking Whitehall that unless the eurozone crisis is contained and managed, it has the capacity to lead to a repeat of 2008, when Lehman Brothers collapsed and banks stopped lending.

The Chancellor said the "remorseless logic" of monetary union was greater fiscal union, a co-ordination at European level of tax and spending.

But fiscal union cannot operate without a strong element of political union. No country could give away control of tax and spending without being part of a political union.

Traditional UK policy has been to oppose steps towards fiscal and political union precisely because it would develop two Europes: those in the core and those on the outside. Mr Osborne clearly believes that is a price worth paying.

There may even be some who would welcome the UK carving out a more detached relationship with the EU.

The shadow chancellor, Ed Balls, also sees a situation where there will have to be closer integration in Europe. Speaking on the BBC's Newsnight programme, he said that German taxpayers would have to guarantee Greek debt.

"That is in the end the price you pay for going into a single currency," he said.

He had not thought it was inevitable that the eurozone would have to have a degree of fiscal co-ordination, but he went on: "The reality is now that without greater burden-sharing and co-ordination the euro will be in deep crisis and I'm afraid the German taxpayer is going to have to be told this is where we are at."

Indecision risks

It is an unusual moment when British politicians, more than the Germans, are urging closer European integration.

Stand by for arguments about a two-speed Europe, although there are strong arguments for being in either lane.

The relationship between France and Germany remains central to the eurozone

Rarely has there been a summit with such a billing. US President Barack Obama has been piling on the pressure.

The President of the European Commission, Jose Manuel Barroso, said ominously that history would judge those taking part if they failed.

The warnings have flown thick and fast - indecision risks plunging the world economy back into recession.

Yesterday French President Nicolas Sarkozy flew to Berlin for seven hours of talks with German Chancellor Angela Merkel. They have apparently agreed a common position.

The Franco-German relationship remains the engine room of the EU. If the past is any guide it will have been the German leader who will have made the greater concessions.

The challenge is this: Greece needs a second bail-out of around 120bn euros (£106bn: $170bn). Greece's debt mountain - that has soared to 350bn euros - needs reducing. Many would argue the country needs growth more than further austerity measures. And the markets would like to see Europeans essentially guaranteeing to stand behind sovereign debt.

Almost certainly Greece's bail-out terms will be made more bearable. The interest rates on the current loans are likely to be lowered and the period for paying them back extended.

The big argument has swirled around Angela Merkel's insistence that this time around private investors - the banks and the pension funds - share some of the pain with taxpayers in bailing out Greece.

Ideas have come and gone. Some have survived and will be debated today. While there are very few details of the Franco-German deal it does appear that the private sector will be involved.

It might be a variation on the plan for banks to exchange their current holdings for much longer 30-year bonds. That could, over such a period, reduce Greek debt.

The question is how the ratings agencies will judge such schemes and whether they declare them a default, which would have unpredictable consequences. If Greece can default why shouldn't Portugal or Ireland, it will be asked. Sources in Berlin suggest their plan would not cause a default, which is so opposed by the European Central Bank.

How will this summit be judged? As Sony Kapoor of think tank Re-Define says, "simply agreeing to a second package for Greece is no longer enough". For him the key is a solution that "unambiguously restores Greece's solvency soon".

He goes on: "Without a clear hope of a better tomorrow that only a significant reduction in debt stock can bring, depositors and taxpayers will continue to flee, entrepreneurs to emigrate and growth-inducing private investment will not take off."

The markets want certainty. A failure to deal with Greece's problems will prompt markets to test whether Italy can be relied on to manage its debt and Italy is simply too big to bail out. It is the fear of drawing Italy into this crisis that will concentrate minds today.