By Paul Taylor
PARIS (Reuters) - Just when Europe needs strong leadership to overcome its sovereign debt crisis, its pivotal leaders, Angela Merkel and Nicolas Sarkozy, have both been weakened at home.
The political fates of the German chancellor and the French president may hinge on their handling of the crisis that began in Greece and threatens to overwhelm the 17-nation euro area.
"If the euro fails, then Europe fails," Merkel often says. She might add that she and Sarkozy would be likely to go down with the ship.
Yet powerful domestic forces are pulling the two leaders in opposite directions ahead of elections in France next year and in Germany in 2013, driving Sarkozy to seek a bold advance in European integration but keeping Merkel's foot on the brakes.
The chancellor is under pressure from voters, influential media and rebels in her center-right coalition to resist any further bailouts after unpopular rescues of Greece, Ireland and Portugal failed to stop the crisis spreading.
Opinion polls show three-quarters of Germans oppose any more aid for Athens. Merkel has said she is doing her best to avoid a Greek default, but indicated that may not be possible.
After a string of state election defeats, she struggled to rally a majority of her own supporters in parliament last week behind strengthening the euro zone's rescue fund.
"This time it has to be enough!" the mass-circulation Bild daily thundered the next day. The conservative establishment Frankfurter Allgemeine Zeitung said the parliament vote was "no carte blanche for a rescue orgy."
Economics Minister Philipp Roesler, leader of the liberal Free Democratic junior coalition party, which has been gutted in recent elections, vowed to oppose any leveraging of the 440-billion-euro fund to increase its financial firepower.
That presages tougher fights to come over a proposed second bailout for Greece, and the creation of a permanent European Stability Mechanism to replace the temporary rescue fund.
Each new Bundestag vote is likely to be more difficult than the last. That could reinforce Merkel's innate caution and resistance to big ideas such as common euro zone bonds or a large-scale joint program to recapitalize European banks.
The chancellor describes her own crisis management philosophy as "driving by sight," advancing "step by step" and avoiding processes that could run out of control.
Critics say the risk is that her small steps could soon be overtaken by uncontrollable events in the financial markets.
"She never takes the lead on anything. She wants to be the person who sums up at the end of the meeting," said a former European leader who attended EU summits with her for years.
By contrast, Sarkozy is under pressure at home to avoid a Greek default, which would harm shaky French banks, and to accomplish some feat of European statesmanship to propel a re-election bid mired in sleaze scandals and economic gloom.
"It is not possible to let Greece fall both for economic and moral reasons," he said after meeting Greek Prime Minister George Papandreou, drawing a parallel with the collapse of U.S. investment bank Lehman Brothers in 2008. "The entire banking system around the world paid the consequences."
Trailing opposition Socialist challengers in the polls, the president suffered a blow last week when his conservatives lost control of the Senate, the upper house of parliament, for the first time since the Fifth Republic was founded in 1958.
That effectively killed off his plan to anchor a "golden rule" on deficit reduction in the constitution -- a commitment he made jointly with Merkel in an effort to reassure markets and shore up France's triple-A credit rating.
A spate of scandals involving alleged illegal funding of conservative election campaigns with kickbacks on arms sales and briefcases of cash from African dictators, as well as snooping on journalists, has undermined Sarkozy's promise to clean up politics and run "a republic beyond reproach."
Long-serving aides and friends have been detained by police and placed under judicial investigation.
Even traditionally supportive news magazines are talking of an "end of reign" atmosphere in his Elysee palace.
With public debt at 86.2 percent and France's credit rating under market scrutiny, Sarkozy has had to eschew pre-election giveaways and draft a tight 2012 budget, curbing public spending and culling more civil service jobs by attrition. Debt service has overtaken education as the biggest spending item.
Unemployment is stubbornly high at 9.6 percent and there is no economic feel-good factor in prospect to fulfill his 2007 campaign promise to be "the president of purchasing power."
Sarkozy's leading Socialist challengers, Francois Hollande and Martine Aubry, centrist hopefuls Francois Bayrou and Jean-Louis Borloo, and even some of his own cabinet are calling for France to take a stronger lead on European integration.
Foreign Minister Alain Juppe, himself once seen as a potential president, came out last week for a "real European federation" with a common economic government and a bigger central budget to sustain the single currency.
In contrast to Germany, there is hardly any political or media questioning in France of the cost of euro zone bailouts, even though Paris is the second contributor after Berlin.
The instinctive French response to the crisis remains "more solidarity" -- read: lend more public money to Europe's weaker brethren. The German reflex is "more discipline" -- read: tougher punishment for deficit "sinners."
Hollande and Aubry both support issuing joint euro zone bonds to bring down the borrowing costs of countries on the periphery and "fight speculation" -- a position shared by Germany's opposition Social Democrats and Greens.
Sarkozy has so far rejected the idea, which has plenty of supporters inside the French policy establishment, chiefly because he knows it is a red line for Merkel.
Seizing the initiative in Europe might be his best hope of confounding the polls and winning a second term, but it would not be without risk.
He might drive nationalist voters toward the far-right National Front of Marine Le Pen, who advocates pulling out of the euro and erecting trade barriers to shield French industry.
Perhaps more importantly, if not carefully handled, a grand Sarkozy initiative for closer European integration could spark a backlash in Germany, causing trouble for Merkel and fuelling panic on the financial markets. The stakes are high.
(Additional reporting by Andreas Rinke in Berlin and Catherine Bremer in Paris; Writing by Paul Taylor; Editing by Catherine Evans)
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