By Luke Baker
BRUSSELS (Reuters) - France's Francois Hollande will push a proposal for mutualizing European debt at an informal summit of EU leaders in Brussels this week, increasing pressure on German Chancellor Angela Merkel to drop her opposition to the idea.
Senior EU and U.S. officials said the new French president raised the idea of bonds jointly underwritten by all euro zone member states during G8 talks at the weekend and would again raise it when EU leaders meet in Brussels on May 23.
He is expected to have firm backing from Italian Prime Minister Mario Monti, Spanish Prime Minister Mariano Rajoy and the European Commission, which has long been a backer of euro bonds.
Germany opposes any early move, saying much more progress is needed on coordinating fiscal policies across the euro zone first. It has the backing of the Netherlands, Finland and others.
The rapid deterioration in the euro zone debt crisis over the past month, with Greece's potential exit from the 17-country currency bloc no longer taboo, has brought the idea back to the forefront, with many economists and policymakers arguing it would be one of the best ways of restoring market confidence.
"The euro bonds debate is back front and centre and Hollande will have support from other leaders if he raises it," one EU official said. "It's not something that's going to happen overnight - there's a lot that needs to fall into place first - but there is a desire for a plan of action toward euro bonds."
In a letter to EU leaders, European Council President Herman Van Rompuy urged them not to have any "taboos" at Wednesday's summit which waqs intended to focus on specific steps to stimulate growth and create jobs across the bloc.
"It is not too early to think ahead and to reflect on possible more fundamental changes," he wrote. "In many ways, the perspective of moving towards a more integrated system would increase confidence in the euro and the European economy."
Slovak Prime Minister Robert Fico told his parliamentarians on Monday he would support France's position.
Growth proposals are expected to include boosting the paid-in capital of the European Investment Bank and plans for 'project bonds' underwritten by the EU budget to finance infrastructure. The aim is to agree ideas that can be formally signed off at the next summit of EU leaders on June 28-29.
The victory of Hollande's socialist party in France has not only shifted the euro zone crisis debate towards growth, it has also given renewed impetus to ideas that Merkel has pushed aside in the past, including debt mutualization.
Merkel has said she is not opposed to the principle of jointly underwritten euro area bonds, but believes it can only be discussed once there is much closer fiscal and economic integration across the euro zone.
That remains a long way off and German officials were quick to reiterate that point on Monday.
"(Euro bonds are) the wrong prescription at the wrong time with the wrong side-effects," German Deputy Finance Minister Steffen Kampeter told German radio.
With Greece facing elections on June 17 that could hasten its departure from the euro zone if voters back anti-bailout parties, Merkel was put under some pressure at the G8 talks in Camp David but refused to budge on her insistence that any growth measures could not come via more deficit spending.
Without her agreement, no major policy shift will be possible.
However, there are glimmers that Germany is willing to increase domestic demand, a move that could help its euro zone partners export more and recover a little.
Germany's largest industrial union IG Metall agreed to a 4.3 percent pay rise on Saturday, giving 3.6 million car and engineering industry workers their biggest increase since 1992. And the Bundesbank has acknowledged that German inflation could reasonably be above the euro zone average for a while.
"German Finance Minister Schaeuble's shift in favor of higher wages, and the Bundesbank's recognition that inflation might rise above 2 pct for a period, are both to be welcomed as positive developments," said Jim O'Neill, chairman of Goldman Sachs Asset Management.
Markets face an unsettling month before the Greek elections and are also looking at the shaky state of Spain's banking system and high debt. Madrid admitted on Friday that its 2011 budget deficit was even higher than first thought.
Economy Minister Luis de Guindos said on Monday economic activity would likely drop by another 0.3 percent between April and June, further fuelling doubts about the country's ability to get a grip on in its finances, although he insisted this year's budget deficit target would be met.
"There has to be a resolution around Greece before any sort of confidence comes back to the markets," Andrew Wells, Global Chief Investment Officer, Fixed Income, at Fidelity Worldwide Investment.
In its paper on what it calls "stability bonds", unveiled in November, the Commission said it was not an idea that could be deferred forever, saying the severity of the crisis - which has worsened since - meant quicker action needed to be taken.
That is language that Monti, an economist and former European commissioner, has supported in the past and is expected to second in the discussions on Wednesday.
"Whatever the timeframe was before on moving towards euro bonds, it's now even shorter because of the worsening in the crisis," a second EU official said.
"There needs to be a discussion on jobs and growth, but there also needs to be a discussion on specific steps that can be taken towards euro bonds."
Economists have argued that the best way of restoring confidence in bonds issued by euro zone sovereigns is for the debt to be collectively underwritten by all countries. However, that would put a vast burden on Germany, the EU's biggest economy, to underwrite the debts of other member states.
"In light of the new direction coming out of Paris, all of these issues will be getting a new hearing," said an EU diplomat, referring to the impetus from Hollande's election.
As well as trying to find new ways of resolving the region's debt problems, EU leaders are also expected to discuss how to tackle a deepening banking crisis, with the banking systems in both Greece and Spain under severe strain.
One idea is to allow the European Financial Stability Facility, the euro zone's 700 billion euro rescue fund, to help recapitalize banks directly, rather than lending to individual countries that then lend it on to the banks.
But Germany opposes direct lending by the EFSF to banks, saying it is up to individual member states to ensure the stability of their banking sectors.
(Additional reporting by Gareth Jones in Berlin and Martin Santa in Bratislava, editing by Mike Peacock)