European Council President Herman Van Rompuy said they decided to end a special summit on the 2014-2020 EU budget, worth about 1 trillion euros, and would try again early next year rather than continue negotiating into the weekend.

"The bilateral talks yesterday and the constructive discussion within the European Council show a sufficient degree of potential convergence to make an agreement possible in the beginning of next year. We should be able to bridge existing divergences," Van Rompuy told a news conference.

"My feeling is that we can go further (in cuts) but it has to be balanced and well prepared, not in the mood of improvisation, because we are touching on jobs, we are touching upon sensitive issues," he said.

The leaders mandated Van Rompuy and European Commission President Jose Manuel Barroso to try to close the gaps between member states in the coming weeks. Officials said the most likely date for resuming the talks was February.

Chancellor Angela Merkel of Germany, the biggest contributor to EU coffers, said she had not expected a deal at the first attempt and played down the consequences of failure, saying there was a real potential for agreement at the start of 2013.

"I have always said that it wouldn't be dramatic if today were only the first step," she told reporters.

The last time the EU held its marathon budget negotiations in 2005, it took six months and an acrimonious failed summit at which Britain wielded its veto before a deal was finally found.

There was no such drama on Friday. But EU officials warned that failure would divert time and resources away from efforts to shore up the faltering euro zone, and reinforce an impression among the bloc's 500 million citizens and among investors that EU leaders suffer from collective indecision.

Financial markets were unmoved by the breakdown, focusing more on growing prospects of a deal next Monday to release urgently needed aid to ailing euro zone member Greece.

If the budget impasse drags on, it could delay programming of hundreds of billions of euros in investments in transport and energy in poorer ex-communist eastern members of the 27-nation bloc, meant to help them catch up with the richer west.

"PARALLEL UNIVERSE"

British Prime Minister David Cameron said a compromise plan tabled by Van Rompuy that scaled back cuts in farm subsidies and regional aid to placate France and Poland was "just not good enough", given the austerity that governments were implementing at home. He said other northern EU countries that contribute more to the budget than they get back felt the same way.

Cameron said a deal was still possible on the EU budget but the European institutions were "living in a parallel universe" and must adjust to the real world of budget cuts.

Lithuanian President Dalia Grybauskaite said Germany, Britain, Sweden and the Netherlands, all net contributors, demanded further cuts of at least 30 billion euros on top of the 80 billion already trimmed from the European Commission's original spending blueprint.

Playing to Eurosceptical images of Brussels "fat cats", Cameron targeted the roughly 60 billion euros earmarked for EU salaries and benefits in 2014-20 for deep cuts, insisting that European officials endure similar reductions in numbers and pay as national officials in some countries.

He handed Van Rompuy a paper setting out ways to trim the bloc's administration bill by 10 percent, including raising the retirement age for most officials from 63 to 68, and capping pensions at 60 percent of final salary instead of 70 percent.

Van Rompuy ignored them in his draft compromise plan but appeared to open the door at his news conference to taking on board some of the ideas, saying they required careful preparation because they touched on personnel issues.

BITTER DEBATE

Negotiations on the EU's long-term budgets are always rancorous affairs, but the depth of Europe's present debt crisis has made the inevitable arguments over farm subsidies and rebates all the more bitter.

With national budgets being cut across much of the bloc, the EU is contemplating the first real terms decline in spending.

"We can't increase spending in the EU when we are cutting at home," Cameron said.

More than two-thirds of the EU's roughly 130 billion euro annual spending is paid out in subsidies to farmers and investment in motorways, bridges and other public works in poorer southern and eastern European countries.

The current seven-year budget worth 1.034 trillion euros in EU financial commitments for the period 2007-2013 was agreed in 2005, at the height of a credit-fuelled boom in public spending.

The Commission initially demanded a roughly 5 percent increase in spending for 2014-2020, equal to 1.091 trillion euros. But this has already been reduced to 1.01 trillion euros under Van Rompuy's compromise, and many net budget contributors insist the total must dip below the trillion euro mark.

Previous deals have been built around Franco-German pacts to defend generous EU farm subsidies against attack from Britain and other northern states. France receives more from the Common Agricultural Policy than any other country, while Germany is also a major beneficiary.

But the need for overall budget restraint now appears to be a higher priority for Germany than safeguarding farm spending, prompting France to ally itself with Poland and former-communist eastern European states to jointly oppose cuts to the two biggest areas of EU spending.

French President Francois Hollande pressed for proposed cuts in farm subsidies to be restored.

One area where Britain stood alone was in its bid to protect its cherished rebate from any cuts. The annual refund worth 3.5 billion euros last year was first won by Margaret Thatcher in 1984, due to Britain's low lower share of EU farm subsidies.

Paris, Berlin and others want to reform the complex system of rebates that also sees linked payments made to Germany, the Netherlands and Sweden. Hollande also said Paris would keep pushing for a change in the way rebates are calculated so that all countries contributed to their payment.

But EU officials accept that Cameron cannot win the support of Britain's euro-skeptic parliament for any deal that scraps the rebate.

(Additional reporting by Andreas Rinke, Peter Griffiths, Catherine Bremer, Ethan Bilby, John O'Donnell, Justyna Pawlak, Robin Emmott, Robert-Jan Bartunek and Jan Strupczewski; Editing by Paul Taylor)

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