By Robin Emmott

BRUSSELS (Reuters) - Eleven months before Barack Obama's historic handshake with Raul Castro, Europe staged its own show of friendliness with Cuba. While little noticed, this gesture may end up doing far more to end the communist island's isolation.

It all happened one hot January day last year at an EU-Latin America summit in Chile. Castro cheerily waved alongside European Commission President Jose Manuel Barroso for the official group picture and then, as the photo gathering broke up, German Chancellor Angela Merkel shook his hand.

This was low key compared with when the U.S. and Cuban presidents greeted each other on December 10 after half a century of hostility. But all this warmth at Nelson Mandela's memorial service in South Africa has brought no radical change and the U.S. trade embargo on Cuba, imposed in 1962, remains.

By contrast, the European Union decided last week to seek negotiations with Havana on increasing trade, investment and dialogue. This will mark their closest contacts after years of tension about Cuba's human rights record, over which the EU imposed its own sanctions until 2008.

While any accord will be modest, Havana said it would consider the EU invitation to talks constructively. Castro needs trading partners as he tries to ensure the survival of the Cuban revolution, which his brother Fidel led, through a transition from hardline communism to a more pragmatic model.

The gesture from Merkel, who grew up in the now defunct East Germany, was all the more notable as her country - along with fellow EU members Poland and the Czech Republic - has been reluctant to deal closely with Cuba, partly out of a lingering distaste for its own communist past.

Gianni Pittella, vice-president of the European Parliament who attended the Santiago summit, said the decision to seek negotiations with Cuba had been a long process that gathered pace in Chile. Europe's strategy is to encourage change.

"Besides trade and investment, I hope it will be possible to begin a structured dialogue with Cuban civil society and with those who support a peaceful transition on the island," said Pittella, who also awarded the EU's human rights prize to Cuban dissident Guillermo Farinas last year.

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The proposed accord, said EU officials, would give Brussels a bigger role in Havana's market-oriented reforms, position EU companies for Cuba's transition to a more open economy and allow the Europe to press for political freedoms on the island.

CARIBBEAN CAPITALISM

The EU is already Cuba's top foreign investor but divisions after the summit nearly ended the overtures before they had scarcely begun.

After the EU's foreign policy chief Catherine Ashton returned from Chile, the draft accord with Havana languished in the European Council's red marble building in Brussels for months, unable to gain the support of all 28 EU members.

Apart from the governments in Berlin, Warsaw and Prague, Sweden also had misgivings about what they regard as Havana's repression of political dissent.

"Four countries felt it was not yet the time," said one EU official who declined to be named. "In the end, the majority was able to convince them that negotiating with Cuba would be a more effective way of bringing change."

What helped to change minds was Cuba's progress in implementing its five-year plan since 2011 which has relaxed the state's grip on the economy. This has been accompanied by a relaxation of curbs on foreign travel and Internet use, as well as a fall in numbers of political prisoners.

An accord with Cuba, which could be agreed by late next year, had been the EU's goal since 1996, although what Brussels is offering is modest for now and is only a starting point.

The EU believes Cuba has the potential to become a dynamic economy like the Dominican Republic, another Caribbean island nation which once depended on sugar exports. It has diversified into manufacturing via free-trade zones that attract investors.

Cuba's problem is that aside from nickel, cigars and rum, it sells little to the outside world. Exports to the EU were worth just 739 million euros ($1 billion) in 2012, barely up from a decade ago.

Still, there are niches to be exploited. Seafood exports have doubled over the past decade and Cuba is trying to attract global shippers to its deep-water Mariel port near Havana.

While it is too early for the EU and Cuba to discuss trade liberalization, a similar accord with Central American states a decade ago led to a deal giving them duty-free access to the EU's 500 million consumers.

PRAGMATISM

Human rights remain the biggest stumbling block. Ties with Cuba were strained when Europe imposed the sanctions in 2003 in response to the arrest of 75 dissidents. All were released into exile later but the Human Rights Watch group says Cuba still punishes dissent with beatings and threats of long-term imprisonment.

Diplomats say any serious violation of human rights during negotiations would interrupt the talks.

Poland, the Czech Republic and Germany have insisted the proposed accord set out steps that Cuba - the Western hemisphere's only one-party state - must take to encourage democracy. One EU diplomat said the document contained "our strongest human rights language yet" in EU affairs.

EU negotiators still want to be pragmatic because progress could unravel if pressure on Havana provokes a backlash, especially in a country where sovereignty is fiercely defended as a tenet of the 1959 revolution. Nevertheless, the issue cannot be swept under the carpet.

"There will be some mention of human rights (in the proposed accord). The Cubans are not going to get away from that," said Paul Hare, a former British ambassador to Cuba.

If the European Union is being pragmatic, so is Castro.

EU officials read Havana's openness to an accord as recognition by Castro - who replaced his ailing brother in 2008 - that Cuba cannot survive forever on its ideological ties with leftist governments in Venezuela, Bolivia and Ecuador.

Cubans make a similar point. "Cuba is becoming more and more realistic in searching for economic partners," said Carlos Alzugaray, a former ambassador to the EU. "Policy will be nuanced by this more pragmatic and realist approach."

Fidel learnt a harsh lesson about relying on a single ally and donor when the Soviet Union's collapse in 1991 plunged the Cuban economy into crisis.

Today, Venezuela is Cuba's biggest trading partner and benefactor but serious economic and political problems there mean Havana worries about losing its economic lifeline.

Ties with China are weak, even though both are run by communist parties. Bilateral trade was just $1.8 billion in 2013, no more than China's trade with the Dominican Republic - with which Beijing does not even have diplomatic relations.

"The feeling in Cuba is that they have to diversify their allies," said another EU official. "After what happened with the Soviets, the Cubans don't want to be let down again." ($1 = 0.7272 euros)

(Additional reporting by David Adams in Miami, Martin Santa in Brussels and Ben Blanchard in Beijing; editing by David Stamp)