Talks to agree a new EU budget will resume today, with Britain expected to table a new proposal offering to cut its rebate further to secure an agreement.
The new offer follows pressure exerted on Britain by Poland and France yesterday, which caused British prime minister Tony Blair to say the future of the EU budget talks "hung very much in the balance".
At the start of a two-day EU summit in Brussels yesterday both states rejected Britain's budget proposal and pressed Mr Blair to provide more money to new member states and cut its annual rebate from the EU exchequer.
One French diplomat said that Britain should put an end to its budget rebate in full and show solidarity with the rest of Europe.
Britain has offered under its current proposal to cut the rebate by €8 billion over seven years. However, France is still seeking cuts of €14 billion for that period.
The rebate is a mechanism agreed in 1984 to compensate Britain for its small agriculture sector. However, with EU enlargement the rebate would be worth €7 billion a year to the British exchequer under the current proposals for the 2007-2013 budget.
Diplomats said they expect Britain to offer to give up more of its rebate but this would not meet the expectations of the French.
Britain is also expected to seek a mid-term review of the EU budget in 2008-2009. This would enable a potential reform of farm spending before 2013 - a move opposed by France and Ireland.
Following a meeting with French president Jacques Chirac before the start of the summit, Mr Blair said a deal was still possible. "It's going to be very tough and very difficult. It is just as well to be frank about that right from the outset. It hangs very much in the balance," he said.
Mr Blair also met the new German chancellor, Angela Merkel, who could play a role in brokering an agreement. Ms Merkel said Germany would not accept a deal at any price.
The British prime minister met his Polish counterpart, Kazimierz Marcinkiewicz, to try to find a compromise on structural funding for Poland. It stands to lose heavily in the €12.3 billion cut proposed in funding for the 10 new member states, when compared with a previous budget proposal tabled in June by the Luxembourg presidency. Diplomats said Poland was prepared to veto a deal unless it was offered more cash.
The Franco-Polish alliance has upped the pressure on Mr Blair, who has enjoyed a close relationship with Poland since enlargement. Yesterday French foreign minister Philippe Douste-Blazy and Polish foreign minister Stefan Meller co-authored a letter to the Financial Times strongly criticising the British proposal.
"The UK presidency has put forward a proposal that cannot become the basis of an agreement . . . The UK has been a champion of enlargement. We trust it will also be willing to cover the costs it presents," it said.
But not all of the 10 new member states are opposed to the British proposal. Slovakia and the Czech Republic both said yesterday it could form the basis of a deal. "I think maybe we can reach an agreement. I am very close myself to agreeing with the proposal," said Slovakian prime minister Mikulas Dzurinda, adding that the British package was better than that offered by Luxembourg in June.
A Swedish diplomat also said there was a feeling of "controlled optimism" over the talks, which are scheduled to end tonight but which could run until early on Saturday.
Failure to clinch agreement would mean the EU having to work out its budget each year and cause a new crisis of confidence following the rejection of the EU constitution in France and the Netherlands earlier this year.