The European Commission's decision to mount a legal challenge against EU finance ministers over the Stability and Growth Pact represents a sharp escalation of the dispute over how to deal with countries that break the budget rules.

The Commission argues that the ministers' decision last November to suspend the pact's rules rather than applying stringent measures to France and Germany was illegal.

The Economic and Monetary Affairs Commissioner, Mr Pedro Solbes, made clear yesterday, however, that the primary purpose of the court action was to clarify where the commission's authority ends and where that of the Council of Ministers begins.

"We all know that the council could have adopted the substance of the Ecofin conclusions in the form of council recommendations, which is what the treaty provides for in this area. But member-states deliberately chose to take an intergovernmental position.

"This changes the nature of the budgetary surveillance and it is therefore useful to have the court's ruling in order to clarify surveillance for the future," he said.

The Minister for Finance, Mr McCreevy, noted that the Commission's legal challenge focused on procedural aspects rather than the substance of November's decision.

For the Commission, however, getting the procedural aspects right is crucial if ministers are not to be allowed to rewrite the EU's rules whenever it is politically expedient.

The German government issued a sulky response to yesterday's decision, chiding the Commission for choosing the path of confrontation rather than co-operation.

The reaction from Paris was quite different, however, with the French government suggesting that the court action could lead to a welcome reform of the Stability Pact.

The French prime minister, Mr Jean-Pierre Raffarin, will discuss the pact with the Commission President, Mr Romano Prodi in Berlin this evening and Paris has made clear that it will push for early changes to the budget rules.

Mr Solbes' spokesman said yesterday that the commissioner would produce reform proposals next month and specified for the first time that the Commission could back changes to the rules themselves rather than their interpretation.

He said that the proposal would seek to combine stricter discipline with flexibility in the conduct of national budgetary policies.

"This can be achieved by, among other things, (i) putting more emphasis on public debt and sustainability, (ii) being particularly strict at the time when the economy is booming and thereby applying more symmetry in budgetary surveillance over the economic cycle, (iii) making more allowance for country-specific differences without putting at risk the equal treatment principle, and (iv) by setting principles for prescribing the budgetary adjustment path and ensuring stronger enforcement," he said.

Such changes could benefit Ireland, which enjoys low public debt but is unable to invest in necessary infrastructure improvements because of the pact's rules.

Mr McCreevy has indicated, however, that he believes that now is not the time to embark on a full-scale reform of the rules.

He told a group of European journalists in Dublin last week that, following the failure of ministers to agree to modest changes to the pact in 2002, he did not believe there was much chance of success now.

He said that many member-states wanted a period of reflection to allow tempers to cool after last November's decision concerning France and Germany.