Merkel is the peacemaker as Blair and Chirac move closer

Europe's acrimonious rift on EU finance was moving towards a resolution last night as Britain prepared to trade a reduction in its annual rebate for a review of all EU spending.

Tony Blair agreed to cede €10.5bn (£7.1bn) from the value of the rebate, and increase the overall EU budget by more than €5bn to soften cuts in aid to the countries that joined the EU last year.

The proposed deal provoked immediate criticism from the Tory opposition for "surrendering" the rebate won by Margaret Thatcher in 1984, without winning bankable cuts in the Common Agricultural Policy. In June, Mr Blair promised he would not negotiate away the rebate.

William Hague, shadow Foreign Secretary, said: "Seldom in the course of European negotiations has so much been surrendered for so little. It is amazing how the Government have moved miles while the French have barely yielded a centimetre."

But Mr Blair insisted the deal was a "fair and reasonable package" which allowed the UK to pay its share of the costs of EU expansion "but preserves absolutely the rebate in respect of the rest of the expenditure".

During a day of tense talks, the new German Chancellor, Angela Merkel, emerged as a key powerbroker between Tony Blair and the French President, Jacques Chirac, as she attended her first European summit. Without the baggage of her predecessor, Gerhard Schröder, Ms Merkel adopted a more neutral stance, mediating between the British and French sides.

The German Chancellor met Mr Blair and M. Chirac separately, then held a meeting with both. She also held talks with the French President, the Austrian Chancellor, Wolfgang Schüssel, and Luxembourg's Prime Minister, Jean-Claude Juncker.

But British officials denied that the Prime Minister's role in the chair had been eclipsed by Ms Merkel. And M. Chirac sought to gain a share in the credit for the emerging deal by saying that there was "no proposal from Madame Merkel but a Franco-German proposal". He also insisted that the British rebate should be phased out after 2013.

Mr Blair, who holds the EU presidency, was besieged by countries demanding he should increase spending from the UK's proposed ceiling of 1.03 per cent of the EU gross national income (GNI), worth €849.3bn from 2007-13. But it was Ms Merkel who opened the way to a deal by suggesting the EU's budget should not be raised beyond 1.046 per cent of GNI, the compromise figure put forward by the UK last night.

Ms Merkel argued that, taking into account British concessions to help the eastern European nations spend EU subsidies, this was equivalent to the blueprint for 1.06 per cent of GNI, or €871.5bn, put forward in June. That gave room for more cash for eastern European countries but without huge increases unacceptable to Mr Blair.

The other key to the agreement was a Anglo-French negotiation over the UK rebate worth around €5bn now and due to rise to more than €7bn by 2013. Mr Blair had already agreed to lop €8bn off its value over the seven years, and was last night poised to raise that total. In exchange France was willing to sign up to a review of all spending, including the €40bn annual budget on farm subsidies. Recommendations would be drawn up by the European Commission in 2008 with decisions in 2009.

Mr Blair has insisted that there must be a possibility of farm spending reform before 2013. France opposed that and stuck to a deal, struck in 2002 and agreed by Mr Blair, under which cash for agriculture was fixed until 2013. M. Chirac is likely to point out that France would, in 2009, veto any changes before 2013. The UK is expected to point out that M. Chirac is unlikely to be president in 2009.

Hopes of a deal rose as leaders shied away from the prospect of failing to decide the budget for the second time in six months.

British wines served at Europe's top table

By Hugh Reilly

Sharpham Beenleigh Red 2003

According to Sharpham's wine manager Duncan Schwab, whose Beenleigh Red was served at the EU summit in Brussels, the Beenleigh bouquet is "blackcurrant, with elegant spicy characteristics". This Devon red is made with a classic Bordeaux blend of cabernet sauvignon and merlot grapes and fermented in American oak barrels for a year before being bottled. "This is a wine which people can't believe is English - it really knocks their socks off," Schwab said.

Tintern Parva Muller Thurgau/Seyual Blanc 2003

Parva Farm Vineyard's medium-white blend is produced on a two-acre estate in Monmouthshire by the husband-and-wife team Colin and Judith Dudley. "It's a lovely fresh wine, really easy drinking, with an almost apply flavour to it," said Judith. "It's great with fish, especially salmon, although I heard they served it with lamb at the summit, which would be OK too," said Mrs Dudley. Parva Farm also sent out their popular dry white Bacchus 2004 to the EU for consideration, but the Council Secretariat preferred the Tintern Parva.