German election puts Europe's ambitions on ice
* EU leaders meet in Brussels on June 27-28
* Summit to tackle banking union, youth unemployment
* German election in September means little progress now
BRUSSELS, June 25 (Reuters) - For the best part of a year, the minds of European policymakers have focused on one overriding issue - banking union.
By establishing stricter oversight of Europe's banking sector and a unified system for dealing with any problems, they hope to draw a line under more than three years of debt and economic turmoil by separating countries from their banks.
For months, a summit of EU leaders on June 27-28 was flagged by officials as an important 'landmark' on the road towards a fully fledged banking union. But it now looks more likely to produce a letdown than a breakthrough.
There are unlikely to be any significant decisions given upcoming German elections, continued disagreement over how banking problems should best be resolved and the fact that financial markets are no longer exerting the same pressure.
"We're in a holding pattern until after the German elections in September," said a senior diplomat involved in preparing files for the summit. "Nothing controversial can happen until then, at least in terms of economic policy."
Ever since banking union started to take shape in mid-2012, Germany has been wary of it. It is concerned that as the currency union's largest and most powerful economy, it will end up on the hook for other countries' debts if a single, EU-wide system for sorting out problems is put in place.
Combined with German frustration at having to bail out weaker eurozone members including Greece and Portugal, it is not surprising Chancellor Angela Merkel wants to keep any banking union controversies out of the debate ahead of the Sept. 22 vote, when she will bid for a third term.
She is being helped by the inability of EU finance ministers to agree on how best to go about cleaning up bad banks. Nearly 20 hours of meetings in Luxembourg last Friday again failed to reach a deal.
As a result, the Thursday-Friday summit will focus on youth unemployment and the need to reinvigorate growth in the EU - worthy goals but ones that some leaders feel are a distraction.
"If we don't discuss a common resolution of banks in crisis at the next meeting, I have a feeling that the December 2013 deadline for this will also not be met," Italian Prime Minister Enrico Letta said last week.
While other countries such as Finland, France and the Netherlands share Italy's concerns about a delay, there is little sign the slowdown is having an effect on financial markets, where minds are more occupied by central bank policy in the United States, Japan and at the European Central Bank.
"Market sentiment is really of the view that banking union will come at some point in time, it's a mid-range goal," said Carsten Brzeski, an economist with ING Bank in Brussels.
"In that respect, Merkel has prevailed. Muddling through has become an accepted and successful policy strategy. Europe is muddling through in very small steps."
The danger is that muddling through becomes complacency or procrastination.
If concrete progress on banking union - originally conceived of as a three-step process involving a single supervisor, a single resolution mechanism and a single bank deposit-guarantee scheme - is put off until after the German election, the chances are that nothing will happen until mid-2014 or later.
It takes around six weeks to form a coalition in Germany, which means the next EU leaders' summit in October will come too soon to deal with the outstanding issues, and it is unlikely much progress can be made before the December EU gathering either, officials acknowledge.
Then early 2014 will be dominated by campaigning for the European Parliament elections in May. If the anti-EU vote turns out to be strong, as expected, it will complicate the appointment of a new president of the European Commission, a process in which the parliament has an increased say.
Policymakers may have to wait until after that process is complete, and perhaps until a new Commission is in place, before they can seriously crack on with implementing banking union.
"Europe is probably capable of making steady, but incremental, progress without an overarching vision for the next few years," said Alex White, an economist with JP Morgan, playing down the prospect of any progress at the summit.
"Leaders look increasingly unlikely to do much that is both additive and transformative for the region in the near term."
While that may be acceptable, it doesn't come without risks.
If the anti-EU vote in next May's elections is particularly strong, and it therefore proves very difficult to appoint new presidents to the European institutions, the EU could find itself in a power vacuum while also not having made any progress on sorting out its banks - one of the origins of the crisis.