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UPDATE 2-EADS, BAE in last-ditch struggle to save merger

(Adds source on deadlock, French spokesman, background, updates shares)

* Doubts over German backing for $45 bln aerospace merger * UK Takeover Panel deadline at 1600 GMT * BAE shares down 0.9 pct By Sophie Sassard and Jason Neely

LONDON, Oct 10 (Reuters) - Talks on a $45 billion European aerospace merger of EADS and BAE Systems were in deadlock hours ahead of a regulatory deadline on Wedenesday, and only the French, German and British leaders can break the logjam, sources familiar with the negotiations said.

With Germany holding out against it, EADS and BAE Systems have until 1600 GMT to declare their intentions and either scrap the merger, ask UK regulators for more time or finalise their plans to create the world's largest aerospace and arms group, employing about 220,000 people.

"Talks are ongoing. A decision is to be announced later today," French government spokesman Najat Vallaud-Belkacem told a weekly media briefing.

"We will keep going until 5 (pm London time)," a person involved in the negotiations said.

One source said the deadlock would only be broken if German Chancellor Angela Merkel, French President Francois Hollande and British Prime Minister David Cameron signalled their approval for more talks.

"Things remain blocked. There has been no movement since last night" the source said.

Securing such an enormous and complicated cross-border deal in a sector where commercial considerations are typically trumped by political, economic and national security concerns was always going to be desperately difficult.

Several sources close to the negotiations said Merkel had opposed the proposal to combine Airbus passenger airplanes with UK defence contractor BAE.

"Merkel is against the deal but has not given reasons," a source involved in the negotiations said.

A spokesman for the German government declined to comment.

British Defence Secretary Philip Hammond said the decision was in the companies' hands and he was waiting for an announcement from them.

At 1108 GMT shares in BAE were down 0.9 percent at 322.4 pence in London, while EADS shares were up 0.34 percent at 26.205 euros in Paris.

Brinkmanship is common in European negotiations, and Franco-German-led EADS - whose full title is the European Aeronautic Defence and Space Company - was itself only created after talks about its structure collapsed and were resurrected weeks later.

But with the current negotiations taking place in a glare of publicity, the margin for manoeuvre is rapidly dwindling.

On Tuesday, French Defence Minister Jean-Yves le Drian said negotiations on the merger had moved forward.

"We had made a lot of progress, I think, but have we progressed enough? That is up to those who initiated the project to say," the minister said.

But by late that evening it appeared that there were three lines drawn in the sand, each of which excluded one of the British, French and German governments, leaving the merger in danger of collapse.

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THREE-WAY TUSSLE

France and Germany want to keep a strong say in the combined company, while Britain wants to protect BAE from state ownership, which could affect its contracts in the United States, where archrival Boeing is based.

Germany and Britain could accept lower state shareholdings than is the case at EADS, which is more than half controlled by France, Germany and Spain, but France rejects that.

France and Britain, meanwhile, could accept unequal stakes between France and Germany, but Berlin demands parity. Sources involved in the deal said Germany also wanted to ensure there was a major headquarters in Munich to counter corporate centres in Toulouse, France, and Farnborough, Britain.

Under rules set by the UK Takeover Panel, EADS and BAE can ask for an extension to their negotiations, but only if EADS "has every reason to believe that it can and will continue to be able to implement the offer".

"Extending the deadline will not change the dynamics of the negotiation and would almost certainly weaken the positions of King and Enders going forward, as it would signal they felt they had no other acceptable options," said David Reeths, Director for consulting at defence analysts IHS Jane's.

Negotiators described the atmosphere as tense and frustrated as bickering immediately broke out behind the scenes to lay the blame elsewhere in case the talks officially break down.

The merger has faced growing unease from investors in both companies who complained they were ill-prepared and lacking information. Many people bought shares in EADS on the strength of its Airbus civil unit, rather than its defence ambitions, while BAE investors were attracted by its dividend yield.

Germany does not currently have a direct stake in EADS, but is represented by industrial ally Daimler AG , which holds just over 22 percent. France holds an identical stake, split between the state and French publisher Lagardere .

The British government holds a golden share in BAE that allows it to block foreign takeovers.

Adding to the hurdles facing the deal, BAE's largest shareholder, fund manager Invesco Perpetual, with 13.3 percent, has said it is not convinced of the strategic rationale for the combination.

(Additional reporting by Matthias Blamont, Arno Schuetze, Paul Taylor, Andrea Shalal-Esa and Tim Hepher; Writing by Tim Hepher and Jane Barrett; Editing by Will Waterman)

((tim.hepher@thomsonreuters.com)(+33 1 49 49 54 52)(Reuters Messaging: tim.hepher.thomsonreuters@reuters.net))

Keywords: EADS BAE/

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