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For some weeks now David Cameron has been arguing against the proposed 6% increase to the EU budget. He and his ministers have used words like "outrageous" and "unacceptable".

The expectation grew that after a honeymoon with Europe the prime minister was intending to go into battle to avoid Britain paying an extra £900 million a year. Gradually it took root that his greatest priority was to .

Then late yesterday and early today his officials briefed that he had accepted that a freeze on the 2011 budget was impossible. The curious part of this is that it was known over the summer that a freeze was not on the cards. Back then the EU Council of Ministers had agreed that they would settle for an increase of 2.9%. Britain did not agree to this, but without a veto had to accept it. An increase of 2.9% would mean that Britain would end up paying an extra £500 million.

That was the agreed negotiating position for talks with the European Parliament, which had voted for a 6% increase. Those negotiations, under the auspices of the Commission, are about to get under way. It would be very difficult if not impossible for Britain to change the EU Council's position.

The second curious fact is that the budget for 2011 is not formally on the summit agenda. David Cameron will have to raise it on the fringe of the discussions or in bilateral meetings. So the attention of the UK press is on an issue that barely warrants attention elsewhere.

Now Downing Street has stressed that the prime minister is playing a long game and that his main interest is in the budget that runs between 2013 and 2020. Negotiations over that are just beginning and David Cameron is searching for allies. He is not alone. The Danes, the Dutch, the Swedes, the Austrians and a few others share his view that at a time of austerity Europe has to join in.

And that brings us to the main agenda of the summit. The 27 heads of government are focused on setting up a new system to ensure that there is no re-run of the Greek debt crisis. In future there will be sanctions to prevent countries running up excessive deficits. There is also in place of the current bail-out funds that are due to expire in three years.

Chancellor Merkel has surprised and angered some other leaders by insisting that such significant changes require a change to the Lisbon Treaty. She wants any change to be legally watertight, knowing that it would be examined by the German constitutional court. Angela Merkel seems to have an ally in President Sarkozy, but few others.

Mr Cameron is against treaty change. It if involved new powers going from Westminster to Brussels then it might trigger a referendum in Britain. But that is unlikely. Britain has an opt-out from any sanctions.

He is instinctively opposed to treaty change for another reason. Some of his backbenchers may see it as an opportunity to try and claw back some powers to London.

But in the horse-trading that is how business is done in Europe, Mr Cameron might just offer to back a treaty change if Chancellor Merkel and President Sarkozy were to support him in his campaign to restrict future increases in EU spending. He is a leader in search of new allies.

It was interesting to note that when David Cameron arrived in Brussels he focused in his public comments on resisting a 6% increase. He did not refer to the 2.9%. It could be that he is preparing the ground for eventually having to agree to a final increase above the 2.9% but lower than 6% - still enough for him to claim a kind of victory.

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Europe's leaders, who will meet in Brussels tomorrow, know broadly what they want. How to get there continues to divide them.

They are still scarred by the debt crisis in Greece which rocked the euro. Some believe that sovereign debt put at risk the entire European project. They want to ensure that never happens again.

So the President of the European Council, Herman Van Rompuy, was sent away in March to toil with a task force to come up with some answers.

In general terms there is little disagreement. In the preface to the draft conclusions it states that a "fundamental shift in European economic governance is required". This will mean increased fiscal discipline, greater economic surveillance and deeper co-ordination.

Strip that down. What the eurozone doesn't want again is a Greek-style surprise, where suddenly they learn of a budget deficit that has risen above 12%. So they want a preview of national budgets. But the aim is to go much further: to enforce sanctions against those who run up excessive deficits, and to set up a permanent mechanism to manage future debt crises.

Where all this becomes more controversial is over how the rules are enforced. The Germans, in particular, want a regime of sanctions against the rule-breakers. The German public don't want again to find themselves bailing out countries like Greece.

Now the fine detail of what those sanctions would be has not been agreed. They could be a combination of fines, or a withdrawal of EU voting rights.

It was presumed that the Germans would back automatic sanctions, but at a a softer line was taken. Sanctions would not be automatic. A minority of states could block them. Now some question whether, if the sanctions are not automatic, they would pack a punch. After all, it would then leave it to national politicians to enforce the rules. But the French wanted the more flexible option and they got their way.

In exchange France agreed to back changing the Lisbon Treaty, which is what the Germans say is necessary. The Germans believe that disciplining states requires a treaty change particularly under the German constitution.

The leader of the Eurogroup, Jean-Claude Juncker, attacked the French-German deal as "unacceptable".

In Germany many MPs are unhappy about dropping "automatic" sanctions. Chancellor Merkel said today that nothing could be agreed in Europe without French-German co-operation. The biggest danger for the eurozone, she said, stemmed from excessive deficits. Even with tougher sanctions another crisis could not be ruled out. A new robust crisis mechanism was needed and that could only be achieved by changing the treaty.

But treaty change opens up a Pandora's Box and the proposal is bitterly dividing member states. For changing the treaty opens up the possibility of other issues being put on the agenda. Some countries might try and reclaim some powers. It would once again involve the EU facing inwards and concentrating on institutional change, just when it has spent eight years doing that.

Treaty change is bitterly opposed by David Cameron. If the change involves any new powers going from Westminster to Brussels he is committed to holding a referendum. The British public could deliver a firm "Non" and set up a European crisis.

Now the British position is that the UK is not in the euro and that any treaty change would not apply to it. Under Protocol 15 of the Lisbon Treaty Britain has an opt-out from any sanctions. And this is David Cameron's key card. If sanctions don't apply then there is no need to call a referendum, as no powers would be ceded to Brussels.

Other countries like Ireland would have to put the change to a referendum and it could easily fail there. With Ireland mired in debt, it would be a hard argument to win to back a suspension of EU voting rights in the event of a country exceeding the 3% deficit limit.

So a number of countries - like the Netherlands, Finland and Ireland - are furious at the idea of a treaty change. They don't want it. Nor do EU officials, like the President of the European Commission, Jose Manuel Barroso. They all fear where it will lead.

The expectation is that President Van Rompuy will be told to go away and find a way of meeting German concerns without a treaty change. It may prove a difficult circle to square.

There is another separate battle line that will surface at this summit: the 2011 EU budget. The European Commission and the European Parliament have backed an increased of 5.9%. Such an increase would cost the UK an extra £900 million a year. David Cameron calls it "outrageous", when countries are slashing their deficits and make painful spending cuts.

He said in Parliament today that the "greatest priority for Britain is getting the EU budget under control". He will find some support from other countries, but may have to compromise - perhaps by accepting an increase of just over 2%. When he was challenged not to roll over in Brussels and if necessary just to say "no" to any increase he side-stepped giving a direct answer. He said it would help if Labour MEPs stopped voting for increases in the EU budget.

On all these issues Europe is divided. Two days of painful horse-trading lie ahead. For David Cameron the difficulty will be explaining to the British people why he had to compromise on the budget - if he doesn't come away with a freeze.

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I was at a recent dinner in Brussels. It was a gathering of insiders: commissioners, directors, ambassadors. The 150 people brought together in a Cinquantenaire museum were a fair smattering of Europe's elite.

What struck me in the speeches and interviews that interspersed our dinner courses was the vein of insecurity coursing through the comments. When the EU Commissioner Viviane Reding was pushed on the issue of the union's unpopularity she took comfort in her view that at least the EU was more popular than most national governments.

It perhaps should not be surprising that beneath confident exteriors EU nerves are jangling. The former US Ambassador to Germany John Kornblum pointed out that this year the EU faced its first "existential crisis" in which the Union "saw the possibility of collapse".

I have spoken to a number of very senior officials who say that in May many did fear that the European project was in mortal danger. The President of the European Council, Herman Van Rompuy, . I am not certain of that, but that was the thinking then and it still pervades the Brussels corridors.

In the midst of the crisis a poll by Eurobarometer found that in many countries the popularity of the EU was ebbing. Fewer than half of voters (49%) across Europe seemed to back the EU. The most pronounced change was in Germany, where voters forced to back the bail-out of Greece and to underwrite a larger bail-out mechanism began to lose enthusiasm for the EU project.

It is a change of mood reflected in the Netherlands. Increasingly voters are questioning whether EU spending is a good thing. Some Dutch officials feel that a line has been crossed; in the past EU projects had unswerving support. It is no longer automatic. The EU has to make a case and justify itself.

Outsiders have cast an even sharper eye on what is happening in Euroland.
, declared the "EU is dying".

It does not seem like that in Brussels, but Kupchan's wider observation was that "Europe is experiencing a renationalization of political life, with countries clawing back the sovereignty they once willingly sacrificed in pursuit of a collective deal". He concluded by saying that "many Europeans... wonder what the Union is delivering for them and they ask whether it is worth the trouble".

And that is the change. The idealism, the grand projects, the dreams of ever closer union have lost their appeal to a new generation. The memories of war have faded. The Cold War has been consigned to history. The great expansion of democracy to Eastern Europe is over. Increasingly Europeans approach the EU like any other institution and ask what is it delivering, what is it for?

The President of the European Commission, Jose Manuel Barroso, says the recent crisis was "the biggest 'stress test' that Europe has faced for many decades. We have passed it."

That may be true, but a European official said to me that Brussels is struggling to find the language, the narrative to sell the Union in difficult times.

Across Europe the dominant concern is the lack of jobs and the insecurity that comes with cuts and austerity.

Recently Philip Stephens in the Financial Times said that politics was being shaped by two impulses: demand that governments shelter voters from insecurity; but also voters alienated by globalisation, who increasingly fear immigration and the changes it is bringing to their societies.

It is often the European way to focus on institutional change, on new services and committees.

But a senior diplomat said to me recently the challenge was not just to prevent another crisis with the euro, it was how to re-engage ordinary people with the European project. To a degree thus it has ever been, but this is a time when voters are focused on cuts, jobs, immigration. Institution-building may be out of step with the times.

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PARIS All over Europe the age of retirement is creeping up. Largely it is accepted as an inevitable change. People are living longer and societies cannot afford their current pension plans. So everyone will have to work longer.

In most countries the argument is accepted. Not so in France. Time and again I have met people genuinely affronted at the prospect of having to work until they are 62.

The polls suggest that a majority of the French people support the strikers in their campaign to defeat pension reform. In their view it is a fight not just about a piece of legislation, but about the French way of life.

Other countries have a less clear impression of what their "way of life" is. The French see retiring at 60 as a key strand in a social contract that has been hard-earned down the years.

So on countless demonstrations I have encountered the fear that pension reform is just a start and that beyond it lies the great unravelling of a much-cherished welfare system.

On one march a theatre company carried a giant puppet representing Marianne, one of the most prominent symbols of the French Republic. Her face was splattered with blood and vultures were picking away at her. The message was not lost on the crowds who lined the streets and applauded; France and most importantly its values were under attack.

The fact is that the social system works well for the middle classes. On the whole they don't want it tampered with.

Now the irony is that President Sarkozy . He was the action man, the moderniser who would drag France into the 21st Century. However, the details of the new France he envisaged were often difficult to decipher. In power there has not been a simple narrative. At one moment he can be backing reform; in another he can be lambasting the evils of capitalism.

That being said, there was a sense, as with Mrs Thatcher in Britain, that he wanted to clip the power of the unions. Some say that the lasting legacy of Mrs Thatcher was to change Britain's thinking about business and wealth. President Sarkozy, too, thought he could change French thinking. He hasn't.

Now the French unions understand that this battle is partly about their power and influence and the French way of having an argument. They repeatedly claim there has been no real negotiation over pension reform. They say it is being imposed, albeit via a law passed by parliament. They want what they call "social dialogue".

What really incenses them is That is another French tradition that stretches back to the Revolution: that the French voice is heard on the streets and that leaders listen and sometimes retreat, according to the mood.

In 2006 a bill was passed in the face of determined opposition to make it easier to hire and fire. President Chirac never signed it. It was a victory for popular protest.

The unions and the left insist that the street is not to be ignored. President Sarkozy says France cannot afford the current pension system and that change must come.

The revolutionary tradition still pervades public life. People say that when you start working for a company the management is regarded as the enemy. Any change can be seen as an attack on working conditions and rights.

So many of the students who have tumbled out of the lycees and universities see the demonstration as a right of passage, of joining a long line of direct action that takes in the student rebellion of 1968, all the way back back to 1789.

Some students see pension reform as threatening their interests. If older people work longer then there will be fewer jobs for the young. They are already struggling with high unemployment. So manning the barricades is the way they express their frustration.

So despite its revolutionary past France can appear deeply conservative, and attached to its way of life.

Recently, while in Washington, I sat in on a conversation about why Barack Obama had lost his popularity. During his campaign he used his life story to say he had lived the American Dream. He embodied it. In office he has struggled to have that fireside conversation with the American people that came so easily to FDR, Reagan and Clinton. Obama has sometimes come across as aloof, distant and cerebral. It has enabled his enemies to paint him as somehow out of touch with mainstream America.

President Sarkozy too is discovering the risks of being seen to undermine the sense people have of themselves, their country and their way of life.

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Timing is everything, or so often it seems in politics. In Strasbourg, members of the European Parliament met to vote on the EU's budget for 2011.

At almost the same hour British voters were learning of the severest cuts to services since World War II.

A thousand miles from Strasbourg, Portuguese MPs were wrestling with their own budget and the inevitable cuts that must come.

And 1,300 miles from where the MEPs were debating, Irish voters were being told that more would have to be squeezed out of hard-pressed taxpayers. Public sector workers, who have seen their wages cut, know that more bad news is on the way. When I was in Dublin two weeks ago the atmosphere was grim.

The mood in Strasbourg, however, was very different. They agreed to increase the EU budget by 5.9% - almost the same level as proposed by the Commission. There were 92 MEPs who voted in favour of freezing the budget, but 564 supported an increase.

British ministers called it "outrageous". One senior diplomat in Brussels called the decision "nuts". Today one British Liberal Democrat MEP, Chris Davies, said it was plain barmy for the EU to be demanding extra contributions from member countries. David Cameron told the House of Commons in London: "We've called for a cash freeze in the size of the EU budget for 2011 and we're working very hard to make the case across Europe."

Quite a number of countries take the British view, although a majority would settle for an increase of 2.9%. There will now be an attempt to reach a compromise between the Council and the Parliament. If no deal is reached, then the 2010 budget continues. That is favoured by the British, who believe it would be in tune with the spirit of the times.

The President of the European Parliament, Jerzy Buzek, defended today's decision. He said: "Cuts cannot be simply populist measures limiting many possibilities - for example, for education, training or research." The Parliament rejected what it called "arbitrary reductions in commitment appropriations... that jeopardise the implementation of Union policies and programmes already agreed".

Of course, the definition of cuts is to reduce or trim commitments already made. Others pointed out that under the EU was building new institutions, like a diplomatic service, that had to be financed.

There is no scaling back the cost of running the EU's institutions, which account for 5.7% of the budget.

Scottish National Party MEP Alyn Smith, who voted to freeze the budget, said: "Freezing the budget for next year would indeed be inconvenient for a number of projects, but some projects could do with a bit of harder analysis."

Now the majority mood in the European Parliament is to avoid wrangles over the budget with member states in the future. The plan of the four largest political groups is to give the EU more budgetary autonomy, with an independent source of income. Raising EU-wide direct taxes will be hugely controversial with member states, and several have already voiced their opposition. But it is now firmly on the Parliament's wish list.

Power usually follows the money. If the European Parliament was to get its way it would greatly enhance its influence and reduce that of the member states. Tax is one of the most sensitive issues for voters and as this argument gathers pace it will be interesting to discover whether Europe's voters back EU-wide direct taxes.

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PARIS On the wide beaches of Deauville they looked like any other couple, bent into the breeze against a pale sky.

The relationship of President Sarkozy and Chancellor Merkel has not been easy. They were once described as two leaders born under different signs. The German chancellor finds the French president mercurial. He, for his part, is wary of a leader who in his view increasingly places the German interest above European solidarity.

Yesterday, on the Deauville boardwalk, they were in harmony, backing a radical rewriting of EU rules. Some say the changes are the most significant since the creation of the euro in 1999.

The purpose of this flurry of meetings is to prevent a crisis in the eurozone recurring.

The key change is that the EU is committed to embracing sanctions against those states that blow their budgets and threaten the eurozone. Much of the detail has still to be worked out. What form will the sanctions take precisely? Will there just be a financial penalty or will voting rights on EU matters be withdrawn?

Running parallel to the summit in Deauville was a meeting of finance ministers in Luxembourg. One of the arguments there was whether the sanctions should kick in automatically or whether there should be some discretion. Germany - presumed to be in the hardline corner - surprised even its friends by backing flexibility.

To bring all this about President Sarkozy and Chancellor Merkel believe that treaty changes are needed. Angela Merkel has long argued that amendments to treaties would be needed. The French president now agrees with her.

The problem with EU treaty changes is that they come with all kinds of baggage. It won't have gone unnoticed that the EU has just spend eight years haggling over a new treaty. Now, however briefly, the union once again will be facing inwards, preoccupied with changing its rules and structures.

Once treaty changes are on the table it may not be easy to limit the agenda to the issue of sanctions. Other countries may seize the opportunity to introduce other changes. Treaty changes may also trigger referendums, where the people get a chance to give their verdict and the outcome can never be guaranteed.

The country most against the idea of a treaty change is the UK. David Cameron simply does not want to handle the problems that may come with it. The coalition government is committed to holding a referendum on any treaty change that transfers power from Westminster to Brussels. The British government reiterated again today "we will not support anything that involves a transfer of powers from Westminster to Brussels".

The European Council President, Herman Van Rompuy, will be charged with negotiating those treaty changes and bringing them to the boil in the spring of next year.

Now initially the sanctions will only apply to those countries in the eurozone, but the Economics Commissioner Olli Rehn wants to extend the new rules to all 27 members. Britain believes it has a clear opt-out from any sanctions.

There is a second part to what was agreed yesterday. The French and German leaders backed a permanent safety net for those countries that run into trouble. At the moment that countries can tap into. When that expires in three years it may be replaced with a permanent fund and a mechanism to manage national insolvencies.

Olli Rehn says all of this is a "litmus test" as to whether "states are genuinely for economic governance or not".

Perhaps. As the Eurogroup president Jean-Claude Juncker says, "the devil is in the detail". Could a country that is determined to run up a deficit, for whatever reason, be prevented from doing so? Will the existence of a permanent bail-out fund encourage countries to act irresponsibly? Will the German parliament agree to a safety net that could end up with Germany bankrolling other EU countries?

The euro is now like a heart patient. It has had the big scare. Now it will be subject to scans and stress tests. There will be much closer surveillance. Other countries will be able to insist on healthy behaviour. The eurozone will be monitored like never before.

What is not getting so much attention are the causes of this crisis. Countries with very different economies are harnessed together in a monetary union. Some of those countries used low borrowing costs to finance a boom. Unit labour costs grew. In order to regain competitiveness years of wage and spending cuts lie ahead. And where will growth come from? And how will jobs be found for the 23 million out of work? That is Europe's real crisis.

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In a speech to young members of her party, Chancellor Merkel at the weekend broke a taboo. She said multiculturalism had "utterly failed".

Up until now mainstream politicians have largely shied away from "identity politics". No longer. The German chancellor was explicit. "This multicultural approach, saying that we simply live side-by-side and live happily with each other has failed. Utterly failed."

To understand this intervention it is worth scrolling back a few weeks. Over the summer the former Bundesbank member Thilo Sarrazin caused a storm of protest with his book Germany Abolishes Itself. His comments about Jews and genetics meant that his views were immediately condemned and he eventually had to resign from the bank.

But the main argument in his book was that Islam did not fit comfortably with Western values. He packed audiences and his book has sold over a million copies. Suddenly Germany was discussing how well its five million Muslims had integrated.

Then the German President, Christian Wulff, stepped into the argument. "Islam," he said, "has become part of German culture". It was right, the president said, for the Muslim religion to be taught alongside others at German schools.

The reaction was not what he may have imagined. The paper Bild splashed a headline asking "Mr President, why are you sucking up to Islam?" Polls suggested the public did not share the views of the president. Of those polled 66% rejected the president's view that Islam was part of Germany. Other politicians began speaking out. The conservative Bavarian Interior Minister, Joachim Herrmann, said "Germany does not want to integrate Islam but to retain its own cultural identity".

This has been the message that has enabled anti-immigration and overtly anti-Muslim parties across parts of Europe to enter mainstream parties.

The Dutch anti-Muslim politician Geert Wilders visited Germany and according to reports There was loud applause.

Angela Merkel has decided that the argument cannot be left to those parties. She told her audience at the weekend that "immigrants are welcome... they must learn the language and accept the country's cultural norms".

Gradually across many parts of Europe the old concept of multiculturalism is being challenged. That had allowed new arrivals to essentially live within their own communities without taking steps to integrate into their new societies. The problem was that separate parallel communities sprang up.

What politicians like Angela Merkel want is for closer integration, for newcomers to take on Germany's "cultural norms". In her view, it is no longer just enough to arrive and to cling to the values and customs of the country they have come from. She is not promoting assimilation, but she is suggesting that newcomers "have obligations" and need to do more to become "German" or "European".

The new thinking is less to celebrate what makes societies different and more what binds them together. The Turkish President, Abdullah Gul, spoke of the need for Turkish migrants in Germany to speak German "fluently and without an accent".

Many migrant communities are understandably wary of "identity politics" and would argue that the barriers to integration often come from society itself, which makes it difficult for them to find jobs. Some in Germany have pointed out that the funding to help migrants learn German has been cut.

But - after the economy - the issue of immigration in country after country is influencing the outcome of elections and mainstream politicians are starting to pay attention.

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Each day a European government wrestles with how to reduce its budget. The cuts are painful. Cherished benefits are being cut or trimmed. Public sector wages are being frozen or cut. Each week protesters take to the streets to mark their outrage.

One of the cheerleaders for the age of austerity is the EU. One commissioner said "we shall have to work harder". Another said "no one can live beyond their means forever - not even governments".

It may come as a surprise to learn that . Today the House of Commons gets a chance to debate the proposal. It comes a week before MPs will discover which programmes are to be sacrificed, in what is billed as a brutal cull of public spending.

Now the British government has opposed the increase in the EU budget. David Cameron has said that "we can't ask our members of the public to pay more in the UK and have to pay more in Europe as well". The Chancellor, George Osborne, calculated the increase would mean an extra £600m in Britain's gross contributions to the EU.

Britain suggested a freeze and got support from Austria, the Czech Republic, Denmark, Finland, the Netherlands and Sweden. But the initial battle was lost. A compromise was reached in which spending would increase by 2.9%.

Privately officials accuse the EU of hypocrisy, of talking the talk over austerity but not walking the walk.

But the matter has not been settled. Under the Lisbon Treaty members of the European Parliament have more powers over the EU's budget. Many MEPs, it turns out, not only Their argument is that much of the EU's money goes towards regional development and infrastructure projects. They see the EU as almost an ongoing stimulus package, where more spending is good for growth. It is, of course, the same argument used by those who say that reducing deficits will harm the recovery.

Whilst some of the extra money goes towards infrastructure projects some of it will support the increase in spending on the EU bureaucracy. Over two years the pay of officials will increase by 3.7%. Civil servants in Spain, Greece, Ireland and Portugal are not so fortunate. They are facing wage cuts and there is a freeze in many other countries.

Some of the extra money will go to finance new institutions set up by the Lisbon Treaty, including a diplomatic service and a presidency.

Now currently there is deadlock between what national governments are prepared to accept and the wishes of some MEPs. There will now be an attempt to reach a compromise deal under the guiding hand of the EU Commission. If no deal is reached then the 2010 budget would continue. That would be just fine with the UK government.

Some MEPs are tired of this way of financing the EU budget. They want the EU to raise taxes directly. "It is opening the taboo subject," said one. France, Germany and the Netherlands immediately rejected the idea of direct EU taxes. It is interesting to know whether voters across the EU would support such an idea.

While on the subject of money, Britain is Mothers would be able to take up to 20 weeks off on full pay. Fathers would get two weeks. However desirable, the proposals would double the cost of maternity leave. An extra £2.4bn a year is the calculation.

National governments across Europe are having to reduce benefits; the EU is seeking to expand and increase them. Two different approaches to a time of austerity.

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PARIS A huge column of strikers and protesters are snaking along the Boulevard de Montparnasse, heading for the Bastille. Huge balloons hover above the floats from the individual unions.

This is the fifth time the unions have taken to the streets against pension reform and the mood is different. They know time is running out. The new pension law has almost been passed.

Many of the protesters are in favour of rolling strikes that could paralyse France. Privately some union leaders concede this battle is lost and are trying to build a political movement to defeat President Sarkozy in 2012.

One change today is that groups of students from the lycees have joined protests. One student leader said that insecurity and the lack of jobs was drawing students onto the streets.

One union leader said to me "this isn't 1968!" He was referring to the student protests that removed a goverment, but he said the government should be afraid when students and workers link arms.

I sense today a greater militancy, that was absent at recent protests. There is more anger directed personally at President Sarkozy. And there are plenty of people who want key groups of workers, like those who work in the power, oil and transport industries, to walk out and force the government's hand.

But even while the marchers began their long procession the French Prime Minister, Francois Fillon, was insisting there would be no more concessions.

Privately the president is saying there can be no retreat. He believes that a climb-down would risk France losing its triple A credit rating. That would force up borrowing costs and would be a humiliation for France.

So a battle of wills is taking place, between a goverment that insists France cannot afford its current pension plan and many workers who believe the French way of life is being compromised because of mistakes by bankers.

This struggle looks set to intensify in the days ahead.

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On four occasions the unions have held massive demonstrations but the legislation - raising the pension age from 60 to 62 - is winding its way through parliament. Within a couple of weeks it will have received final parliamentary approval and, after that, the time for protesting will be over.

So this round appears to be the critical one - the "defining moment" as many papers are describing it. Some of the unions are flirting with the nuclear option: a rolling strike where unions, particularly in the transport sector, vote for an open-ended strike beyond a strike on the 12th. On Saturday they are planning another day of protest.

As has happened before, the issue of controversial reform will be settled on the French street. In 1995 President jacques Chirac backed down over pension reform in the face of a three-week transport strike. And then in 2006, Prime Minister Dominique de Villepin withdrew employment contracts, after students turned out in huge numbers to fight the measures, which would have made it easier to remove workers.

So, if some unions go for an open-ended strike, it will be a straight clash between demonstrators and the government. The government has made its concessions; the unions have rejected them. As the paper Le Monde says "pension reform is the turning point in Sarkozy's presidency". "Failure," the paper added, "will sink him".

France cannot afford its current pension arrangements and this reform is intended to be a hallmark of Nicholas Sarkozy's presidency. If he were to back down he would be an empty suit, a bundle of energy without purpose.

His opponents are divided. Some are against a rolling strike. The UNSA union - drivers of the metro - have voted to work normally. However there are attempts to enlist high-school students in the protests. And then there is an ongoing strike involving port workers that threatens to close off fuel supplies. La Mede oil plant will have to shut down in a couple of days. Workers at most French refineries have backed rolling 24-hour strikes from 12 October. If France were to experience fuel shortages, the pressure on the government would mount quickly.

But polls suggest the public won't support rolling, wild-cat strikes that brings France to a standstill. President Sarkozy will be hoping that there is a silent majority who back him.

There are wider implications to what happens. It could influence others in Europe. On one level, there is not much sympathy for French workers who protest at a pension age going up to 62. Much of Europe is settling for a retirement age of 67.

Many other Europeans raise an eyebrow over the French refusal to compromise on what they see as the French way of life.

But this particular strike is a weather vane. If the protestors were to succeed it would embolden others. There have already been general strikes in Greece and Spain. A general strike is due in Portugal. In the UK, the rail union leader Bob Crow suggested that British workers follow the French in opposing pension reform.

So this is a critical moment. Increasingly workers are understanding that cuts may not be a one-off. Some countries like Spain and Ireland may have to embrace years of cuts to regain competitiveness, while the unemployment queues refuse to shrink.

Europe's unions know, too, that there are sharp divisions over the wisdom of embracing austerity. Cutting the deficits remains the new orthodoxy in Europe but there are plenty of economists who are arguing that demanding greater austerity will undercut the uncertain recovery.

So as the battle lines are drawn up in France, Europe will be watching.

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Tory supporters who are wary of Brussels have had lean pickings from the coalition government so far.

Today the Foreign Secretary, William Hague, promised them that the sovereignty of the British Parliament would be placed on the statute book for the first time. He told the Conservative Party conference that the clause on EU Law would underline "this eternal truth: what a sovereign parliament can do, a sovereign parliament can also undo".

The principle of parliamentary sovereignty is currently rooted in common law. The intention of the new legislation is to put beyond speculation where ultimate sovereignty lies.

In future it will not be possible to argue in a British court that ultimate sovereignty has shifted to the EU. This was the issue that lay behind , when Steve Thoburn faced a charge for selling bananas by the pound.

Today was intended to reassure Conservatives that the government was not weakening over its previous commitments. In November 2009 David Cameron had promised a Sovereignty Bill. "This is not about Westminster striking down individual items of EU legislation," he said then. "It is about an assurance that the final word on our laws is here in Britain."

It puts Britain in a similar position to Germany, where and that ultimate authority lies with the bodies established by the German constitution.

For both countries it is a question of drawing a line in the sand and saying to Brussels: "thus far but no further".

William Hague said the government's approach to Europe would be "hard-headed", supporting "determined action, not institutional empire-building".

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Some imagine, mistakenly, that they have quietly joined the endangered species list.

Before the UK election there was fear in Europe that a British Conservative Party would usher in an era of hostility towards Brussels. The new intake of Tory MPs were said to have a "visceral" dislike of the European project. This was a party committed to repatriating powers from Brussels.

The leader of the Liberal Democrats, Nick Clegg, before the election accused David Cameron of having chosen European allies who were "nutters" and "homophobes". It was assumed that Cameron would have strained relations with Merkel and Sarkozy and that Britain once again would be isolated in Europe.

Then came the election and coalition government and everything changed. The Conservative-Liberal Democrat nuptials were scarcely completed when the idea of "repatriating" powers from Europe was quietly dropped.

Almost immediately David Cameron signalled he wanted to co-operate with Europe. Paris and Berlin were his first ports of call. William Hague said the new government wanted to be activists in Europe. They emphasised areas of agreement. The Tories wanted to extend the single market and David Cameron set himself up as the champion of Turkey's entry into the EU.

The crisis in the euro helped. It was widely seen as a flawed currency. The Liberal Democrats were forced by circumstances to curb their enthusiasm. The Tories believed their distaste for the Euro had been justified by events.

The government would not use British money to bail out the euro, but there was no schadenfreude coming from London. A strong, healthy single currency was in everyone's interest - that was the official line and that, too, played well in Europe.

Part of this was the reality of sharing power with Nick Clegg, a man who cut his political teeth in Brussels. But before the election David Cameron decided he would not choose fights over Europe. Sure he had told the electorate "I want to be in Europe but not run by it". But in power he had no intention to get drawn into fights over Europe, which had destroyed previous Conservative prime ministers. The Conservative leadership, as far as was possible, wanted to park Europe as an issue.

So the smiling faces of British ministers have charmed the suspicious in Brussels. And it has gone beyond presentation. The government has accepted over banks and financial institutions. A second watchdog will oversee markets and securities and a third pensions and insurance. Even though some argue that these bodies will give EU officials "a mandate to enforce EU laws at the expense of national regulation," the UK government has not objected.

The government has not stood in the way of an expansion of powers in the field of justice and home affairs and Britain has accepted despite its costs and its ambitions for Europe to "speak with one voice".

Now this has not gone unnoticed by Tory activists who believe the party's views on Europe are being diluted. A poll of activists found that 71% regarded it as unacceptable to drop proposals to bring back powers from Europe.

One commitment the government is sticking to is to introduce legislation to hold a referendum on the transfer of new powers to Brussels in any future EU treaty.

But for both activists and the government more challenging days lie ahead.

There is the matter of the British rebate. The EU Budget Commissioner Janusz Lewandowski has already hinted that the rebate is "no longer justified". This year it is worth £3.1bn.

The rebate is of totemic significance to many in the Tory party. It was won by Margaret Thatcher in 1984, when she banged the table and demanded "our money back". Many in the Tory party will expect David Cameron to keep the rebate. But, in extremis, would he veto the entire EU budget to preserve the British rebate? It's what officials refer to as the "nuclear option".

Then there are the Commission's proposals to enforce sanctions against those countries that breach debt and deficit levels. Initially they will only apply to countries in the eurozone, but the Commission hopes to extend this to all 27 countries including Britain. British officials have already been briefing that "the UK is exempt from all sanctions". The British say that . Many in the Tory party will expect David Cameron to use that opt-out if necessary.

In the proposals to get an early glimpse of national budgets the government has said that British budgets will be delivered to the Westminster parliament first. But there are officials in Brussels determined to be involved at the earliest stages of drawing up the budget. Will the UK compromise?

William Hague has pointed out that there is a "profound disconnection between the British people and what has been done in their name by British governments in the European Union". In power the government has chosen to be pragmatic, choosing carefully its battlegrounds. It may not be what the activists hoped for, but the real tests lie ahead. They will define what kind of European David Cameron is and whether he has laid to rest Europe as the most divisive issue within his party.

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Portugal announced it would cut civil servants' wages by 5%.

The Republic of Ireland has put a figure on the giant black hole in its banking sector and the public sector unions know that further cuts are on the way, when the budget is delivered in December. The Irish Finance Minister, Brian Lenihan, did not pull his punches: "a fundamental reappraisal of the public sector will have to take place".

In the UK unions are holding their breath for the spending review on 20 October.

Most of the cuts are not made from conviction that a smaller public sector would be beneficial; they are driven by necessity, the necessity to reduce budget deficits. Some like the Tea Party in the United States argue for smaller government. You don't hear much of that in Europe.

Most European leaders support what is called Europe's way of life with strong social protection. What they are wary to say is that the future will be different. But the other day Frits Bolkestein, a former EU commissioner, said: "the party is over...we shall have to work longer and harder, more hours in the week, more weeks in the year, and no state pension before the age of 67".

Among the protesters such views are rejected. One woman I spoke to in Spain this week said that workers had struggled for a hundred years to get the rights and benefits that they now had, and they were not prepared to watch them whittled away when it was the banks that had caused the crisis.

So far there have been pockets of anger, but most of the protests have been muted. In protest after protest that I have attended the majority of demonstrators have been union members. Rarely have the protests drawn wider support.

France, to a degree, is the exception. Protests against raising the retirement age have been huge. Although only 7% of France's workforce is in unions, some of the demonstrations have attracted families who have no union connections.

In Greece, where the violence has been greatest it has come mainly from anarchists who have attached themselves to union demonstrations.Turnout has tapered off at recent rallies. The main private sector union has said it will not strike against the cuts, but the public sector is not resigned to the new era of austerity and has vowed to launch further strikes.

But across Europe this is not 1968. The protests have not been enough to rock governments or to force a retreat on cutting spending and benefits.

It could still happen, particularly if growth is postponed and unemployment remains stubbornly high.

Portugal's largest union has called for a general strike in late November. Other protests are planned across Europe but so far they have not threatened governments.

I was in Dublin on Thursday, as was the former American President Bill Clinton. He quoted from Yeats to give this warning: "too long a sacrifice makes a stone of the heart". He urged political leaders to go beyond urging voters to "take the bitter medicine". There had to be a strategy that promised "new investment and hope" .

Therein lies the risk. For Europe has a long way to go to emerge from this crisis and 2011 is the year many governments have earmarked to make the deepest cuts. Ireland has had two years of austerity cuts and at least another two are in prospect.

Unemployment remains stubbornly high: 23 million Europeans are without jobs. Many at the moment see the era of austerity as a necessity. You hear, as I did from those who opposed the strike in Spain this week, that there is no alternative.

But what happens if late next year there are few green shoots? Many analysts put growth in the EU at around 1.6%. That will not be enough to spark a strong recovery. For governments the harder times may well lie ahead.

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