With just over two days until a 1600 GMT Wednesday deadline set by the UK, the aim is to make sufficient progress over the central issue dogging the talks to allow BAE Chief Executive Ian King and Tom Enders of Franco-German EADS to seek an extension.

BAE's top investor questioned the very rationale of the $45 billion deal.

Plans by Airbus parent EADS and UK arms firm BAE Systems to create the world's largest aerospace and defense company must overcome a knot of political concerns over security and jobs.

"If they can get the central issue of shareholding resolved, then there'll probably be some more time to tie up other issues like headquarters, weights on the board and other matters," said a senior diplomat following the negotiations.

"Otherwise, Enders and King have signaled they will pull the plug on the 10th".

Officials failed to resolve incompatible demands over state involvement in a video conference on Friday. EADS and BAE denied German reports that the talks had collapsed.

There were few signs of progress after private contacts at the weekend. Plans have already been drawn up to request extra negotiating time, but the companies are unwilling to release pressure by deploying them until they have some real political progress to show UK regulators, banking sources said.

People close to the talks said the UK appeared most open to the deal, Germany was the least keen and France wanted more time to think it over. Yet as problems pile up, all sides have moved to deflect the responsibility in case the talks break down.

Despite the negative atmosphere left by Friday's press briefings, industry experts say it is too early to say whether the world's largest defense merger will happen but note the parties are used to negotiating down to the wire or even beyond.

EADS was created from a merger in 2000 only after talks between France and Germany broke down and the plan collapsed, bringing the two sides back together to negotiate a complex shareholder pact limiting the role of the French state.

However, those negotiations were held in secrecy while a blizzard of publicity surrounding the latest talks has brought pressure from investors and unleashed new negotiating demands.

BAE's top shareholder Invesco Perpetual blasted the proposed deal on Monday, citing state interference, poor terms and a lack of strategic rationale. The investment company, which has 13 percent of BAE, is reported to have clashed in private with BAE leaders as soon as the talks surfaced last month.

BAE shares dipped 1 percent. EADS was fractionally lower.

SOVEREIGNTY

In order to improve the chances of winning approval in the U.S., Britain wants France to commit in writing to forego any future increases in its shareholding, which would start out at 9 percent under the proposed 60:40 split between EADS and BAE.

France has told partners it has no intention of upping its stake but is unwilling to surrender sovereignty over future industrial policy. Barring a wider escalation of the problems surrounding the deal, sources briefed on the discussions said a formula would probably be found to get round the impasse.

Government leaders are being kept in the loop on the negotiations but there are so far no plans for direct intervention or a three-way summit, officials said.

Britain left open the door on Sunday to a German state participation in EADS-BAE in a move towards addressing Berlin's demands for equal treatment with France in the new group.

Germany has renewed demands to have the headquarters and is involved in potentially tough negotiations with EADS about job guarantees and company conditions on continued defense orders.

"Whether this can be resolved depends on whether everyone wants this to work", the diplomat said.

The United States is seen likely to want assurances that a system of co-operation in EADS between French and German governments or their industrial allies will not be resurrected.

Any risk of foreign state control is crucial as Washington considers whether to impose new conditions on the way BAE operates in the U.S. - a red line for the company and the UK.

Negotiators are keen to keep respective state shareholdings under 10 percent to avoid stirring U.S. concerns over possible foreign influence on its defense sector, an issue seen certain to be highlighted by Boeing and other U.S. rivals.

U.S. experts said this weekend anything over that figure would undermine the chances of U.S. approval [ID:nL1E8L62EI].

(Additional reporting by Kate Holton, Andrea Shalal-Esa, Paul Taylor, Spohie Sassard; editing by Janet McBride)

• A Permanent Economic Emergency