The agreement between Merkel and Sarkozy was struck at a surprise meeting in Berlin on Wednesday night during discussions lasting more than six hours in the chancellery after several weeks of wrangling between euro zone partners over the terms of a new bailout package for Greece.
They were unexpectedly joined for more than one hour by European Central Bank President Jean-Claude Trichet, a government spokesman said.
Their decisions were taken in consultation with Herman Van Rompuy, the president of the European Council, who hosts the summit.
The meeting between Merkel and Sarkozy was hurriedly arranged during a telephone conversation on Tuesday and the leaders of Europe's two largest economies apparently wanted to demonstrate once again that they hold the key to an agreement on a major issue affecting the future of Europe.
The euro zone leaders have been under pressure in the past weeks to reach a speedy agreement on a second rescue package of about 120 billion euros in order to send a strong message to increasingly nervous financial markets that they will act decisively to deal with the Greek crisis and safeguard the stability of their common currency.
A second rescue package over a year after Greece received 110 billion euros became necessary to avert the Greek crisis spilling over to larger euro zone economies such as Spain and Italy. Their borrowing costs soared to record levels in recent weeks as speculators began targeting them as the next candidates for a bailout.
The proposed new rescue package will ensure that Greece will remain solvent till 2014.
Merkel and Sarkozy have been at loggerheads in the past few months over involving private banks and insurance and hedge funds in the planned second bailout of Greece and their dispute blocked an agreement at previous meetings of euro zone leaders and their finance ministers.
While Chancellor Merkel pressed for involving private creditors to share the costs of the proposed bailout, Sarkozy favoured voluntary involvement, fearing that French banks with huge exposure to Greece's debts will suffer heavy losses.
Private creditors' participation is crucial for the chancellor to win the support of her coalition partners for the proposed new bailout.
The two leaders are also divided on the issue of rescheduling Greece's debts, which gained great significance in recent weeks as one of the options to deal with the debt crisis and thereby safeguard stability in the 17-nation euro area.
The German government on Wednesday reiterated its demand that the private sector should be involved in the second bailout.
Economics Minister and Deputy Chancellor Philipp Roesler said for the functioning of financial markets, it is absolutely necessary that finance investors carry the risks of their own engagements.On the eve of the summit, European Commission President Jose Manuel Barroso made an impassioned appeal to the euro zone leaders to bury their differences and "do everything necessary to stabilise the euro" and not to delay a solution any longer.
"The situation is very serious and a solution must be found," he said.
"Nobody should be under any illusion, the situation is very serious. It requires a response. Otherwise the negative consequences will be felt in all corners of Europe and beyond," he said.
He said a top priority for the euro zone leaders is to put Greece's finances on a solid footing.
They will also have to decide to what extent private investors will be involved in the proposed new bail out for Greece, he suggested.
