UPDATE 1-Europe considers euro zone budget, pooling borrowing
* Report charts path for tighter integration in euro zone
* Paper from EU's Van Rompuy recommends central budget
* Report suggests countries pool short-term funding
(Adds detail, background) By Luke Baker and John O'Donnell
BRUSSELS, Oct 12 (Reuters) - Euro zone countries should consider clubbing together to borrow as well as paying into a central budget that could be used to help struggling countries, according to a report prepared by senior European officials ahead of a meeting of leaders.
The interim report, prepared by Herman Van Rompuy, who as president of the European Council will chair a summit meeting next week, charts a path towards closer fiscal integration among the 17 countries using the euro as they struggle to contain an economic crisis.
In the interim paper obtained by Reuters on Friday, officials write of the need to explore a central budget for countries in the euro zone.
Van Rompuy's thinking - firmly backed by Germany - is that some form of "fiscal capacity" among the euro-area countries will allow them to iron out labour market and other socio-economic imbalances that build up in the bloc.
The fund could be used to help a country such as Spain, which has unemployment of 25 percent and is struggling to reinvigorate growth. In exchange for budget rigour, the pan-eurozone fund could provide targeted assistance.
"One of the functions of such a new fiscal capacity would be to facilitate adjustments to country-specific shocks by providing for some degree of absorption at the central level," officials wrote.
The 27 countries in the European Union currently finance a budget which amounts to around 130 billion euros a year - 1 percent of EU output - and which is used for spending on agriculture, science, infrastructure and other areas.
But there is no equivalent budget among the 17 countries that share the euro, a shortcoming that many economists believe has undermined the stability of the currency project.
Germany and France strongly support the proposal and, in a surprise to many EU diplomats, Britain does too, but for different reasons. London sees a euro zone budget as a way of further separating Britain and its increasingly EU-sceptical electorate from the currency bloc and its problems.
The report, prepared in conjunction with the president of the European Commission, Jose Manuel Barroso, the president of the European Central Bank, Mario Draghi, and Jean-Claude Juncker, the president of the Eurogroup of finance ministers, also addresses the contested idea of pooling country borrowing.
The report, which will be finalised in December, advocates examining "the pooling of some short term sovereign funding instruments, for example, treasury bills, on a limited and conditional basis."
Such a move in the short term would be viewed sceptically by Berlin, which is reluctant to see weaker countries in the bloc piggyback on its economic strength in order to borrow more cheaply.
Berlin may, however, be prepared to consider such a move in the distant future after Europe has taken significant steps towards a tighter political and fiscal union.
(Reporting By Luke Baker and John O'Donnell; Editing by Catherine Evans)
Keywords: EU EMU/REPORT