David Cameron's entire European strategy has been thrown into doubt less than two weeks before his landmark speech on the European Union as Germany backs away from initiating negotiations that would give Britain a chance to claw back some powers from the EU.
Amid growing German rhetoric against British Eurosceptics – including a warning that they are seeking to "blow up" the EU's single market – diplomatic sources said Angela Merkel was abandoning plans to call for a major revision of EU treaties.
The chancellor's move will come as a blow to the prime minister, who is expected to say in his long-awaited EU speech, due to be delivered in the Netherlands on 22 January, that he would use a major treaty revision to renegotiate the terms of British membership.
In common with every member state, Britain would have a veto in the negotiations which Cameron would use to create a new settlement. He would then put this to the British people in a referendum if he won the general election in 2015.
It is understood that Merkel, the only EU leader who has been calling for a revision of the Lisbon treaty to underpin new governance arrangements for the eurozone, has given up on the idea of a major treaty revision for the moment.
The German chancellor is said to have decided it is fruitless to push for a treaty revision in the face of strong opposition from France and elsewhere. Instead she has decided to try to stabilise the eurozone by setting up what are described as "work streams" in three areas. These cover banking union, the subject of the last EU summit where Cameron won guarantees for Britain; greater fiscal co-ordination among eurozone members; and labour market reform across the EU.
But Britain made it clear on Friday that it still expects an opportunity to renegotiate the terms of its membership when George Osborne warned that the UK might be forced to leave the EU if the existing settlement is left unchanged.
In an interview with the German newspaper Die Welt, which took place on Tuesday before a Merkel ally criticised the UK for seeking to "blackmail" its partners, Osborne said: "I very much hope that Britain remains a member of the EU. But in order that we can remain in the European Union, the EU must change."
The Treasury confirmed that the translation of the interview was accurate, though a source played down the significance of the chancellor's comments. "This is consistent with what we have said," the source said. "We want to remain in the EU but the EU needs to change, and indeed is changing."
But Germany is showing growing irritation with Britain. Georg Boomgaarden, the German ambassador to London, dismissed the Eurosceptics' belief that Britain faces a choice between "pick-and-choose or out".
The ambassador told the Guardian columnist Jonathan Freedland: "This is really a choice between out and out … If you pick and choose you blow up the single market."
Boomgaarden's intervention follows the warning by the chairman of the Bundestag's European affairs committee, Gunther Krichbaum, that Britain should not seek to blackmail its EU partners.
Philip Gordon, the US assistant secretary for European affairs, spoke out against a referendum on Wednesday as he said that Washington wanted Britain to remain a "strong voice" in the EU.
The leader of the Conservative MEPs warned that strident Euroscepticism was in danger of giving the impression of Britain "snarling like a pitbull across the Channel". Richard Ashworth told a seminar organised by the Business for New Europe group and the European parliament: "We're raising the tempo so that expectations are becoming too great." He warned that Britain was making itself "pretty unattractive and difficult to work with".
Douglas Alexander, the shadow foreign secretary, said: "This week British business, then the Americans and then the Germans, joined a growing chorus of concern about the real risk of David Cameron pushing Britain towards exit from Europe. This is not a prime minister in control of the agenda, or even of his party. It is weakness and not principle that is now driving David Cameron's thinking, yet sadly he seems intent on putting the unity of his party over the best interests of the country.
"Labour are clear that any decision on a referendum should be based on changes in Europe, not movements in the polls. We believe Britain's interests are best served by focusing on reform in Europe, not exit from Europe."
British officials are familiar with Merkel's thinking on a treaty revision. They believe that after the European Central Bank's success governor Mario Draghi in stabilising the euro, Merkel sees less urgency in formalising arrangements for a fiscal union.
But they believe the basic idea that eurozone governance arrangements will need greater democratic accountability underpinned in an EU treaty will eventually come to the fore again. "Europe is dealing with an existential crisis," one British source said.
Vince Cable, the business secretary, showed Liberal Democrat unease about the prime minister's plans which he described as a "massive disruption". He said: "I have to say that this whole issue of raising again in a fundamental way British membership and the terms of membership is a massive disruption and deeply unhelpful in my job. I have to spend my time talking to business people, British and international, trying to have the confidence to invest here and create employment and the recent uncertainly is just deeply uncomfortable for the country. I think the warning shot across the bows yesterday from the United States was actually quite helpful as well as very timely."
guardian.co.uk © Guardian News and Media Limited 2010
image: © Dirk Vorderstrasse