EUROPEAN leaders gather in Brussels tonight for a budget showdown, bringing to a climax an annus horribilis that has seen the EU stagger from one setback to another.

With the community mired in a constitutional crisis, economic stagnation and a crippling lack of public legitimacy and political leadership, heads of government insist that a deal on the seven-year budget at the two-day summit is essential to put the Union back on track.

Tony Blair, whose presidency of the EU would be tarnished without a positive result, gave warning that failure to reach a deal, “would cast a real shadow, not just over the European Union, but over the future of enlargement too”.

José Manuel Barroso, the European Commission president said that the “credibility” of the Union was at risk.

But hopes for a deal that would break the budget deadlock were fading last night as one leader after another shot down the eleventh-hour compromise proposal unveiled by Jack Straw, the Foreign Secretary, yesterday.

Britain proposed to increase the budget for 2007-13 marginally by €2.5 billion (£1.7 billion) to €849 billion, but ruled out giving up any more of its rebate than the €1.1 billion a year it had already conceded.

Mr Blair has insisted that the €5 billion-a-year rebate should stay intact until Paris agrees to scale back farm subsidies that account for nearly half the EU budget and go predominantly to France.

Yesterday’s proposal contained a few sweeteners for the new member states from Eastern Europe, which are still reeling from Britain’s proposal to cut €14 billion from their development funds for new roads and businesses.

However, the carrots for Eastern Europe failed to placate Kazimierz Marcinkiewicz, the Polish Prime Minister: “This proposal, if it stays as it is, will be met by a veto from Poland. Everything in it is minimalist, and does not satisfy us at all.”

Algirdas Brazauskas, the Lithuanian Prime Minister, was also unimpressed. He said: “I am authorised to vote against the new proposal by Great Britain.”

France would also reject the deal unless the British rebate were scrapped, Philippe Douste-Blazy, the Foreign Minister, said. “We hope that the British authorities will understand the need for a complete review of its rebate mechanism. Without a change on this point, France will not give its agreement.”

The British proposals call for a review of the Common Agricultural Policy in 2008, but France has ruled out any change to a system that gives 131,000 of its farmers more than €20,000 a year in subsidy.

President Chirac has all but won his battle to stop Mr Blair reforming the budget to spend less on farming and more on industries of the future.

The countries least dissatisfied seemed to be the Netherlands and Germany — two big paymasters of the EU — who are happy that the plan to cap the budget at just 1.03 per cent of GDP will limit their contributions.

The British Government hopes that a deal can be reached because the situation is unpopular across the Union, all leaders have different reasons for wanting to resolve the impasse quickly, and they know that Britain will be less willing to compromise after it relinquishes the presidency on January 1.

Failure to reach agreement this week would not cause an immediate financial crisis because the new budget does not take effect until 2007. But it would add to the political problems that have engulfed the Union since France and the Netherlands — two of the founder member states — rejected the draft constitution in the summer.

Those No votes highlighted the growing divide between Europe’s elite and its people, deepened the rift between Britain and France over the EU’s direction and called future expansion into question as citizens succumbed to “enlargement fatigue”.

The economic stagnation in much of the eurozone has lead to a rise in protectionism and nationalism, particularly in France, as countries turn in on themselves. It has also undermined faith in the EU’s biggest project, with polls showing that majorities no longer support the euro in France, Germany and Italy.

“It’s Europe’s blackest year — no to the constitution, no to economic reform, no to reform of the budget, almost a no to Turkey, a possible no to the world trade talks,” Denis MacShane, Britain’s former Europe Minister, said. “Europe is in a mess. People are dispirited.”

With the fear of another great European war fading and the more recent collapse of the Soviet threat, the purpose of the EU and its promise of “ever closer union” is being increasingly questioned and provoking uncharacteristic introspection among the Union’s biggest cheerleaders.

“This crisis is not only about the EU constitution or the budget negotiations. It runs deep into the core of Europe,” Jean-Claude Juncker, Luxembourg’s Prime Minister, said recently.

In a rare note of contrition, the arch-federalist who had declared that people should be made to vote repeatedly on the European constitution until they voted yes, wrote in a Brussels newspaper: “As we yielded to the temptation to clad our laudable ideas in grand words, we failed to recognise that rather than inspiring Europeans, we actually scared them.”

ANNUS HORRIBILIS

May 29 France overwhelmingly rejects the proposed EU constitution, with 55 per cent voting ‘no’

June 1 The Dutch follow suit, with 61.6 per cent voting rejecting the constitution

June Italian MPs call for Italy to abandon the Euro, as public support for the single-currency diminishes

June 17 Budget talks break down. Britain refuses to cut its budget rebate. France refuses to cut farm subsidies. Jean-Claude Juncker, the Prime Minister of Luxembourg, then the EU president, says that the EU is “in deep crisis”

October German elections result in a coalition government, hindering reform of the EU’s largest economy

December José Manuel Barroso, the European Commission President, dismisses Britain’s compromise budget as unacceptable and unrealistic

December 13 EU’s farm subsidies under fire as world trade talks open in Hong Kong