All Gibraltar takes to the streets in angry protest at plans for settlement with Spain

Angry at plans to dilute British sovereignty, and unimpressed by offers of a financial sweetener from the EU, flag-waving Gibraltarians brought the Rock to a standstill yesterday with a demonstration which mobilised almost everyone in the colony.

Most of the 30,000 residents turned out – many waving Union flags – for a rally which highlights the difficulty which Britain faces in persuading Gibraltarians to accept a constitutional settlement with Spain.

Gibraltarians shrugged off the prospect of an Anglo-Spanish solution to the 300-year-old dispute over their status bring ing a multi-million-pound EU aid package. Indeed, the British Government was put on the defensive over reports that EU leaders had agreed at a summit last weekend to set up a fund worth up to €60m (£37m) to help boost the local economy.

Although the leaders backed the principle of funding for Gibraltar and Spain if the status of the Rock can be resolved, the European Commission said it has yet to identify how EU structural funds could be used or what sums would be involved. The Foreign Office conceded that "the details of the funding are not yet agreed".

The rally was the culmination of a campaign of fierce opposition from Gibraltarians over Anglo-Spanish plans for a deal on their future, led by the chief minister, Peter Caruana.

Britain and Spain, whose prime ministers are close allies within the EU, now believe that they are closer than at any time during three centuries of friction to resolving the dispute over Gibraltar. Its status is a running sore which has poisoned an otherwise blossoming political partnership between the two countries.

London and Madrid expect to produce joint proposals this summer which will almost certainly suggest a sharing of sovereignty, possibly accompanied by a renunciation of Spain's claim to the Rock. They would be put out for consultation before the 30,000 residents are offered a referendum.

Mr Caruana has refused to take part in the discussions unless he is given the same status as the two governments, and has mounted a high-profile international protest.

He rejected charges that Gibraltar would suffer economically unless it normalises its relationship with Spain, arguing yesterday that sovereignty was "not for sale".

"Gibraltar is a prosperous democracy, it has a prosperous economy and political stability," he said. The people would oppose "done deals cooked up over their heads and against their wishes".

The effect, he said, would be to "curtail our rights, to legitimise the Spanish sovereignty claim and, in effect, to say to us 'sooner or later you are going to have to be Spanish – if you don't want it to be now it's up to you to choose the timing in the future'."

Peter Hain, the minister for Europe, insisted that there was no question of the EU handing Gibraltar to Spain. But he added that the two nations "need to break this historic impasse" and spelled out the prospects for EU funding.

Cash could be made available to "to regenerate the airport and for developing the harbour into the foremost container port," Mr Hain said. Earlier he argued that, in combination with the neighbouring Spanish port of Algeciras, Gibraltar could become "the biggest and most effective harbour in southern Europe".

While aware of the concerns of the people of Gibraltar, the Government is determined to press on with the search for a settlement. Talks with Spain began last year, reviving the so-called Brussels process started by Margaret Thatcher in 1984. The next round of negotiations is scheduled to take place in mid-April in Spain.

Tony Blair sees the centre-right Spanish premier, Jose Maria Aznar, as an ally in his attempts to forge alliances with other governments within the EU. At a summit in Barcelona last weekend the two premiers were the leading proponents of plans for economic reform.

Gibraltar has been a constant irritant, its disputed status complicating a host of EU initiatives. At one point, a row over the Rock blocked a proposal, backed strongly by both the British and the Spanish governments, for a single European sky, designed to create a united airspace, reducing costs for airlines and and increasing safety for passengers.

The British Government believes that the model it adopted for the peace process in Northern Ireland could work for Gibraltar too. In that case, a deal was agreed only after London and Dublin had worked together to put pressure on the parties to accept a deal.

But persuading the people of Gibraltar may be another matter. A referendum held in the colony in 1967 showed that more than 12,000 were against moves to consider a Spanish Gibraltar, with those in favour numbering just 44.