ANGELA MERKEL and François Hollande have broken the ice. Relations between the German chancellor and French president started frostily when Mr Hollande was elected last year, and became still chillier of late. They gave up the practice, common in the past, of cutting deals ahead of European summits. But now, as if to make up for lost time, they have drawn up a ten-page declaration in the run-up to the summit starting on June 27th.

Has the Franco-German motor restarted? To cynical Eurocrats, the partnership was always, in part, about hiding German strength and French weakness. With Germany unusually powerful and France unusually feeble, a long paper may provide the perfect cover. Pledges to fight youth unemployment are easy to make. But the tone of contempt for the European Commission will worry many smaller member states.

To many, the declaration is a German victory on substance and a French success on future form. Germany has delayed key moves in the creation of a banking union, especially an accord on the euro zone’s rescue fund to recapitalise troubled banks, until next year, well after the German general election.

In return, France won support for stronger “economic governance”. There would be more summits of the 17 euro-zone leaders; a permanent president of the Eurogroup of finance ministers; and euro-zone-only meetings of other ministers, for example, of labour, industry and social affairs. This is all part of a peculiarly French obsession with creating a smaller, more exclusive and more overtly political Europe—to the exclusion of non-euro states such as Britain.

French and German officials claim to have made a breakthrough in setting up the pillars of a banking union by the middle of next year. The aim is to stop crippled banks and weak sovereigns from pulling each other down by creating European bodies to oversee the banks and deal with those that go bust. The issue boils down to two questions: Who decides? And who pays?

A euro-zone supervisor will begin work next year. But it is of limited use unless backed up by a European “resolution” body with the power to wind up or restructure crippled banks, ideally with access to common funds (see article). The trouble is, Germany does not want to pay for other countries’ mess. Officials say this would violate the EU’s treaties and, even if these could be bent, the German constitutional court would not wear it.

Thus a curious battle over terminology: the European Commission wanted a centralised resolution “authority”; leaders spoke of a “mechanism”; and Germany proposed a looser “network” of national resolution authorities and funds (yet to be created). The compromise drafted by Mrs Merkel and Mr Hollande speaks of a “board” involving national authorities. The declaration’s next paragraph speaks of “an appropriate and effective private backstop arrangement”. Here “arrangement” is in the singular, not in the plural, as in past EU documents.

Voilà! claim the French. With a single letter the Germans have crossed the Rubicon. They accept that they can be overruled by a European authority that can use pooled money (raised from the banks themselves). Not quite, reply the Germans. For a decade or more, the resolution fund will be short of money. Any bank wind-up will thus rely on the taxpayer. And the use of German cash will require a vote in the German parliament. Expect months of wrangling after the commission issues its formal proposal later this month.

And what of “economic governance”? Fiscal rules have been toughened in the crisis. The commission is charged with monitoring budgets and “economic imbalances”. There are binding sanctions for rule-breakers, and the commission can recommend detailed reforms. As the recession has deepened, the emphasis has shifted from deficit-cutting to promoting structural reforms. But the commission is operating at the limit of its legal powers and of political acceptance. A plan to have countries sign “contracts” to enact reforms, perhaps in exchange for money, is stuck.

The commission’s diktat

Last month France was delighted to be granted two more years to meet its deficit target of 3% of GDP. Yet Mr Hollande bridled when the commission urged him to overhaul pensions and cut spending as well as liberalise the economy. “The commission cannot dictate to us what we should do,” he declared.

For the French, economic policy cannot be left to unknown technocrats in Brussels. Democratic legitimacy requires that its broad outline be debated and agreed by les chefs. Would pension reform be any more palatable if dictated by Mrs Merkel rather than by commissioners? Surely not. But among his peers, a French president is better able to block reforms he dislikes, or at least to trade them for concessions, such as harmonising taxes and adopting a minimum wage across the euro zone.

Most European countries dislike Franco-German stitch-ups, but are even more upset when the two cannot agree. If the euro zone is ever to be pulled out of the mire, the Franco-German motor must work. A compromise between France and Germany, because they are so different, usually wins the support of others. But not all agreements are equally desirable.

A good deal would see Germany agree to an effective banking union that pools at least some of the risks in the euro zone, while France accepts the need to liberalise its economy, deepen Europe’s single market and drop barriers to international trade. The danger is that Mrs Merkel and Mr Hollande will strike a bad deal: create a half-baked banking union that fails to stabilise the euro zone, allows France to avoid necessary reforms and blunts the competitiveness of everybody else. That might be worse than no agreement at all.

Economist.com/blogs/charlemagne