In a statement Telecom Italia said that its board "approved the principle of an industrial alliance" with Deutsche Telekom.

Telecom Italia said however "it wanted clarification of the means with which the German government would limit the use of its voting rights in the new merged company".

The German government currently owns 75% of Deutsche Telekom, a stake it says it wants to reduce during the coming years.

If both sides can thrash out their final differences the merger would rank among the largest corporate deals ever, worth more than $200bn.

It would dramatically alter the corporate landscape of Europe and revolutionise the telecommunications industry.

The new entity would be the world's largest operator in terms of market capitalisation and number of fixed lines and the second based on international traffic volumes and domestic mobile phone subscribers, according to a Telecom statement .

However, the merger could still be scuppered by last-minute wrangling over the stakes the two companies take in the combined group.

Deutsche Telekom was seeking a majority stake in the new venture, but the Italian government prefered a 50-50 arrangement.

A joint press conference had been planned first for Tuesday and was then postponed until Wednesday.

EU objections

The European competition commissioner, Karel van Miert, has already said that the deal would come under close scrutiny from the regulators.

Both companies would have to sell their holdings in many markets in order to get the commission's approval.

French objections could be another obstacle to the deal.

France Telecom has told its partner Deutsche Telekom that strategic agreements between them could be threatened if the German company strikes up an alliance with Telecom Italia.

France Telecom and Deutsche Telekom are strategic partners in the loss-making alliance Global One, along with US operator Sprint, and have a string of other European joint ventures.

Merger talks

Deutsche Telekom and Telecom Italia confirmed late on Sunday that they were in talks on forming a possible "industrial partnership".

The aim of such a $200bn deal would be to create the first real pan-European telecoms giant capable of facing up to US rivals.

The German government owns seventy five percent of Deutsche Telekom

A report in Germany's Handelsblatt newspaper said that Deutsche Telekom shareholders would own 60% of the new company, while Telecom Italia shareholders would own 40%.

Handelsblatt also reported that if the merger happened, Deutsche Telekom would postpone the capital increase of up to $11bn it announced last Thursday.

It added that in a second step following the merger, income from the capital increase could be used to acquire British telephone company Cable & Wireless. C&W refused to comment on the speculation.

Name games

Another potential stumbling block is how to name the merged company. Both Deutsche Telekom and Telecom Italia are former monopolies with strong brand names.

Taking on a different name could hurt either business, and analysts say that 'Deutsche Telekom Italia' would help neither company.

Telecoms mega-merger

The merger deal would be the latest twist of a riveting European business saga which could lead to one of the largest mergers ever seen.

If the talks survive a possibly treacherous birth that includes problems with Deutsche's partial state ownership and calls by Italians for an equal partnership, the offspring could be a telecommunications giant worth more than $200bn (£124bn).

Deutsche Telekom would play the role of a white knight, preventing the Italian group from falling into the hands of compatriot Olivetti.

Telecom Italia Managing Director Franco Bernabe has been scrambling to ward off a hostile takeover bid by Olivetti after his defence plan went up in smoke last weekend when shareholders failed to give him their backing.

Olivetti swooped on Telecom Italia in February with a 10 euro per share cash, share and bond offer, later increased to 11.50 euros per share.

But analysts said any deal between Telecom Italia and Deutsche Telekom would not be guaranteed a smooth passage.

"The hurdles are very high. The governments would have to agree, the Brussels and German regulators would have to agree," said WestLB Panmure analyst Holger Grawe.