Like many other EU summits over the past two years, the European Council meeting in Brussels on June 28th and 29th has been billed as a ‘last chance’ to save the euro. With the situation in Greece, Spain and Italy causing alarm, EU leaders should present a credible plan to convince financial markets that they are serious about saving the euro. They are unlikely to do so. Although there will probably be other last chances, time is starting to run out. Unless France and Germany can soon agree on a grand bargain, disaster may loom.

Not only France but also Italy, Spain, the European Commission, the IMF and the Obama administration are urging Germany to accept ‘eurobonds’ (collective eurozone borrowing), bigger bail-out funds that can intervene in sovereign bond markets and a ‘banking union’ that would include common deposit insurance and bank recapitalisation schemes. For now, however, Chancellor Angela Merkel is not budging.

According to one EU official who has worked closely with Merkel, she reacts badly when other governments ‘gang up’ against her: recent public criticism from François Hollande, the French president, and Mario Monti, the Italian prime minister, has only made her more stubborn. But the official points out that since the euro crisis began she has carried out several U-turns (for example, by agreeing to set up bail-out funds). She has also told fellow EU leaders in private that the euro is in Germany’s national interest and that if, in a crisis, new measures are required, she will take them. What she will not do is spell out in public the steps she is prepared to take, lest that encourage other governments to relax their efforts to curb budget deficits and enact reforms.

When Merkel says that she will do whatever it takes to save the euro she is presumably sincere. But in a crisis would she be able to move quickly enough? She faces severe domestic political constraints. Many Bundestag members oppose greater generosity to southern Europe. In that they reflect German public opinion, which is becoming more hostile to bail-outs. Furthermore, Germany’s constitutional court could block further transfers of power to the European Union. Most of the eurobond schemes that have been mooted would be incompatible with Germany’s current constitution. The German constitution can be changed if two thirds of Bundestag members vote for an amendment. However, if Merkel required the votes of the opposition Social Democratic Party (SPD) to change the constitution, her coalition government would probably collapse.

Not unreasonably, most Germans are reluctant to support schemes such as eurobonds unless other eurozone countries are willing to submit their economic policies to more control by EU institutions. Otherwise the southern Europeans could borrow cheaply via eurobonds and then spend freely. Monti and Mariano Rajoy, the Spanish prime minister, are willing to accept more EU control. But Hollande has not yet indicated that he is willing to do so. Many senior figures in French politics, including the foreign minister, Laurent Fabius, oppose transferring more powers to the European Commission.

Hollande’s current policies are making it hard for Germany to change its stance on the euro. He appears allergic to the kinds of structural economic reform that would boost France’s waning competitiveness, such as deregulating labour markets (he is lowering the pension age while other European governments are raising it). He says he is committed to a budget deficit of 3 per cent next year – which would mean a restrictive fiscal policy – but has so far announced no spending cuts and several spending increases. State spending is 56 per cent of GDP (the highest in the EU after Denmark) and growing. A swathe of new taxes on business is likely to discourage investment and thus stunt economic growth. For the time being, Hollande appears no more willing than Nicolas Sarkozy was to give the EU a bigger say over French budgetary policy.

The story of the euro, like that of the EU itself, is one of Franco-German bargaining. The current disconnect between Paris and Berlin is destabilising the euro. In the long run the euro is not sustainable without a grand bargain between France and Germany. Germany will need to accept the principle of eurobonds, some sort of banking union, softer budgetary targets for the countries in difficulty, and the writing off of more of those countries’ debts. In return France and the other euro countries will have to swallow both structural reforms that would enhance productivity, and greater EU sway over budgets and other economic policies.

At the moment such a grand bargain is impossible, and not only because Paris and Berlin are far apart on policy. Merkel and Hollande do not trust each other. The history of Franco-German relations suggests that even when two leaders initially get on badly (think of Jacques Chirac and Gerhard Schröder, or Nicolas Sarkozy and Angela Merkel) they eventually find a way of working together.

However, the financial markets may not wait. The next eurozone crisis could be imminent, perhaps provoked by a bank run in Spain or Italy, or those countries having to pay so much to borrow that they are effectively frozen out of the bond markets. Those who wish the euro well must hope that in an emergency, Merkel and Holland will overcome their differences, act decisively and bring along the other leaders with them.

But the intrusion of democracy could spoil the best efforts to salvage the euro. In the Netherlands, parties that oppose austerity at home as well as more money for bail-outs could win September’s general election. Monti’s government of technocrats, increasingly unpopular in Italy, could fall long before the elections that are due next spring. Within the past few days both Wolfgang Schaüble, the German finance minister, and Sigmar Gabriel, the SPD leader, have said that big changes such as eurobonds could well require a referendum in Germany.

Many things can go wrong, but if France and Germany work together the euro has a sporting chance of survival. The EU institutions can play a role in bringing them together. Ever since the euro crisis began, the Commission, in particular, has been marginalised from some of the decision-making on the most important issues. The gravity of the current situation presents an opportunity for the institutions to reclaim some intellectual leadership. The ‘four presidents' report’, published on June 25th, shows that they are trying to do so.

Written by the presidents of the Commission, European Central Bank, Eurogroup and European Council – with Herman Van Rompuy, president of the European Council, in the lead – the report sketches a way forward on banking, fiscal and economic union. It calls for common systems for banking supervision, deposit insurance and bank resolution. It also suggests more EU control over national budgets and levels of debt, alongside tentative steps towards debt mutualisation (it mentions short-term ‘eurobills’ and a ‘debt redemption fund’, kinds of eurobond that may be compatible with the German constitution).

The four presidents’ report offers EU leaders a sensible roadmap for their future work. However, Merkel’s response, expressed to law-makers in Berlin on June 26th, was to say that she did not expect to see eurobonds in her lifetime. She is, in the words of the EU official quoted at the start of this piece, “practising brinkmanship, which of course entails the risk that one falls into the abyss”.

Parts of this article are based on a piece that appeared on the Guardian website on June 25th 2012.

Charles Grant [1] is director of the Centre for European Reform.