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UPDATE 1-Europe considers euro zone budget, pooling borrowing

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* 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 shouldconsider clubbing together to borrow as well as paying into acentral budget that could be used to help struggling countries,according to a report prepared by senior European officialsahead of a meeting of leaders.

The interim report, prepared by Herman Van Rompuy, who aspresident of the European Council will chair a summit meetingnext week, charts a path towards closer fiscal integration amongthe 17 countries using the euro as they struggle to contain aneconomic crisis.

In the interim paper obtained by Reuters on Friday,officials write of the need to explore a central budget forcountries in the euro zone.

Van Rompuy's thinking - firmly backed by Germany - is thatsome form of "fiscal capacity" among the euro-area countrieswill allow them to iron out labour market and othersocio-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 toreinvigorate growth. In exchange for budget rigour, thepan-eurozone fund could provide targeted assistance.

"One of the functions of such a new fiscal capacity would beto facilitate adjustments to country-specific shocks byproviding for some degree of absorption at the central level,"officials wrote.

The 27 countries in the European Union currently finance abudget which amounts to around 130 billion euros a year - 1percent of EU output - and which is used for spending onagriculture, science, infrastructure and other areas.

But there is no equivalent budget among the 17 countries thatshare the euro, a shortcoming that many economists believe hasundermined the stability of the currency project.

EURO T-BILLS?

Germany and France strongly support the proposal and, in asurprise to many EU diplomats, Britain does too, but fordifferent reasons. London sees a euro zone budget as a way offurther separating Britain and its increasingly EU-scepticalelectorate from the currency bloc and its problems.

The report, prepared in conjunction with the president ofthe European Commission, Jose Manuel Barroso, the president ofthe European Central Bank, Mario Draghi, and Jean-ClaudeJuncker, 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, advocatesexamining "the pooling of some short term sovereign fundinginstruments, for example, treasury bills, on a limited andconditional basis."

Such a move in the short term would be viewed sceptically byBerlin, which is reluctant to see weaker countries in the blocpiggyback on its economic strength in order to borrow morecheaply.

Berlin may, however, be prepared to consider such a move inthe distant future after Europe has taken significant stepstowards a tighter political and fiscal union.

(Reporting By Luke Baker and John O'Donnell; Editing byCatherine Evans)

((john.odonnell@thomsonreuters.com)(+32 2 287 68 17 or +32 47569 15 89)(Reuters Messaging:john.odonnell.thomsonreuters.com@reuters.net))

Keywords: EU EMU/REPORT