French President Sarkozy slams UK Prime Minister Cameron’s decision to opt out of euro fiscal union

BRUSSELS, Belgium — For the European Union now, it's divided we stand.

The agreement reached just before dawn on Friday will usher in profound changes to the way the EU works, effectively splitting the EU into two. Paradoxically, that may well be what is needed to hold the Union and its shared currency together.

Under the deal, at least 23 of the 27 EU nations, including all 17 that use the euro, will form a new inner circle, signing up to a German-led drive for much tighter economic integration in response to the debt crisis.

Euro-skeptic Britain will stay on the sidelines. Hungary, Sweden and the Czech Republic are holding back pending talks with their parliaments, but are expected to sign up too, leaving Britain isolated.

British Prime Minister David Cameron refused new EU rules, fearing a loss of national independence and a threat to the financial power of the City of London's banking sector.

More: Europe agrees new fiscal union treaty – without UK

“I'm going to say 'no.' I'm going to use the veto,” Cameron said. "We're never going to join the euro and we're never going to give up this kind of sovereignty that these countries are having to give up."

The split will institutionalize Britain's semi-detached relationship with the EU. It allows the others to push ahead with a new treaty enshrining an unprecedented level of economic coordination that German Chancellor Angela Merkel believes is essential to restore market confidence in euro-zone economies and prevent a repeat of the debt crisis that has wracked Europe for the past two years.

"The 17 states of the euro-group have to regain credibility. I've always said that and I believe with today's decisions this can and will be achieved," Merkel told reporters.

Under the deal, the euro-zone nations, plus most of the EU members currently outside, agreed to introduce constitutional guarantees committing to near- balanced budgets. There will be sanctions for nations that break the budget rules. Governments will have to submit national budgets in advance to scrutiny by EU headquarters in Brussels, which will have powers to request changes if it sees too much borrowing.

The agreement largely follows Merkel's blueprint. Any qualms that smaller nations had about handing over economic sovereignty to a union in which a German-French duo has become the dominant driving force, with France very much a junior partner, were countered by the realization that Merkel will not free up German economic power to save the euro without securing budget discipline from the likes of Italy, Spain and Greece.

More: The euro zone's real crisis, weak leadership

"Given the situation of the euro, budgetary discipline is unavoidable,” acknowledged new Belgian Prime Minister Elio di Rupo.

Serious questions remain about how the new rules will work. Germany's idea is for the EU's central institutions — the European Commission and the European Court of Justice — to enforce the new rules. However, there are political and legal doubts about whether institutions set up to work for the full bloc of 27 members can serve the interests of the new inner circle. Cameron has made clear that Britain will have powers to veto the EU institutions operating in areas it considers contrary to its interests.

If that happens, some believe the result could eventually be Britain's exclusion from the EU.

“The UK is out. This is undoubtedly the biggest setback for Britain's European policy since France vetoed their entry in the 1960s,” said Piotr Maciej Kaczynski, an expert at the Center for European Policy Studies, a Brussels-based think tank. “It's a completely new dynamic now. It's terra incognita, we just don't know what this new union is.”

The soured relations between Cameron and French President Nicolas Sarkozy showed how far the economic crisis has shifted the political fault lines in Europe. Just a year ago the two signed a ground-breaking defense agreement in which France and Britain agreed to pool key military materiel. They then joined together to spearhead the NATO operation that toppled Muammar Gaddafi's regime in Libya.

But in a tense night of negotiations in Brussels, the bad blood between them was clear, with Sarkozy clearly exasperated by what the French perceived as a Britain putting protection of its banking sector above the wider European interest.

"David Cameron made a proposal that was unacceptable to us, a protocol to the treaty that would have exonerated the United Kingdom from a great number of financial service regulations," Sarkozy told a pre-dawn press conference. “We couldn't accept this. On the contrary, part of the world's current troubles stem from a lack of regulation of the financial sector."

More: Requiem for a euro zone bailout

Previously, EU nations would have dragged out negotiations to find a compromise. But this time, the pressure from the markets for swift action, and widespread impatience with the British stance, led the others to move ahead without London.

Comments of nations that are traditionally closer to Britain's pro-market views emphasised the feeling of British isolation. Dutch Prime Minister Mark Rutte accused Cameron of using the summit to gain an “unacceptable” competitive advantage for London's financial over the likes of Amsterdam, Luxembourg and Frankfurt.

Even Sweden, another non-euro nation that declined to immediately sign up to the new rules pending consultations with its parliament, expressed concern about the British position. “Worried that Britain is starting to drift away from Europe in a serious way. To where? In a strong alliance with Hungary," tweeted Swedish Foreign Minister Carl Bildt.