* Officials say early-March phone call decisive in German shift
* Merkel makes emotional plea at closed-door party meeting
* Social Democrats on board for hard line against Putin
* German leader faces challenge to keep EU united
By Noah Barkin
BERLIN, March 20 (Reuters) - On a Sunday in early March, a day after Vladimir Putin won parliamentary backing for an invasion of Ukraine, Angela Merkel called him to demand an explanation. The German leader was shaken by what she heard, sources within her party say.
For weeks, in a series of phone calls, the Russian president, speaking mainly in the German he perfected as a KGB agent in East Germany, had assured the chancellor he would respect the territorial integrity of his western neighbour and had no plans to intervene militarily.
Merkel, in turn, had been preaching caution on punishing Russia in her talks with the United States, hopeful that Putin would eventually back down and accept proposals to ease the crisis.
But on the March 2 call, according to German sources, Putin dropped all pretence and coldly admitted to sending Russian troops into Crimea.
The conversation seems to have sapped what little faith Merkel still had in Putin, according to officials in Berlin and Washington.
The Germans came away convinced the Russian leader had deceived them in order to win time to tighten his grip on Crimea. Putin could no longer be trusted.
Merkel later called U.S. President Barack Obama to vent. The German government declined comment.
"It's not as if we had any illusions about Putin, but before this we at least had the impression that there was some degree of respect there," said one German source, who spoke to Reuters on condition of anonymity.
According to several officials, the call between the leaders was a turning point in Berlin's approach to the crisis.
Despite Germany's heavy dependence on Russian oil and gas, extensive business interests in the country and long-held view of Moscow as a "strategic partner", Merkel swung quickly behind the punitive measures she had been warning against for weeks.
Four days later, at a hastily called EU summit in Brussels, where leaders set out a three-step plan to ratchet up sanctions against Russia, she was among the most vocal proponents of a tough line, according to participants.
On Thursday, ahead of another summit, she warned in a speech in parliament that Europe was prepared to move to politically sensitive "phase three" measures, including economic sanctions, if Russia refused to back down.
The coming weeks will be crucial in determining whether Europe has the stomach to deliver on that threat.
They will also show whether Merkel, who emerged as Europe's dominant leader during the euro zone debt crisis, can keep 28 member states with different economic and political interests united and firm in their approach to Russia.
"If she puts her foot down, few will defy her," said an EU official.
During the euro crisis, Merkel was often criticised for her cautious approach -- for resisting the "big bazooka" solution that some of Germany's partners and many leading economists felt was needed to prevent the single currency from breaking apart.
In private meetings over the past weeks, she has sketched out a similar plan for sanctioning Russia, saying Putin's "Nadelstiche" or pin-point provocations on Ukraine's eastern border should be mirrored by slowly escalating measures from Europe.
But it would be wrong to confuse this "step by step" approach with a lack of determination.
Since her fateful call with Putin, she has sent abundant signals that she will not shy away from confrontation with Russia, despite pressure from German industry and opinion polls which show a solid majority of Germans are against full-scale economic sanctions.
Last week, at a closed door meeting of lawmakers from her conservative party, she showed rare emotion, according to participants, in criticising Putin and signalling to colleagues that Germany must be prepared to accept an economic backlash from tougher sanctions.
Top aides, when asked about the consequences for German companies of an economic war with Russia, reply that political principles are more important than profits.
"This may be Merkel's moment, the time when she shows unusual boldness" said Ulrich Speck, a senior fellow at the Carnegie Europe think tank, drawing a parallel with her cautious mentor Helmut Kohl's sudden embrace of German reunification when the Berlin Wall fell.
"Confronting Russia would be a bold step and until now she has done everything to avoid it," he said. "But she could take that step."
During last year's German election campaign she was accused by her Social Democrat (SPD) opponent Peer Steinbrueck of showing a lack of passion for Europe in the euro crisis because she was brought up in communist East Germany.
The time around the opposite may be true. Having grown up behind the Iron Curtain in a Soviet garrison town, it is hard to imagine a crisis that would arouse more resolve in the pragmatic physicist than this one.
Regardless of how Europe as a whole reacts, Germany's experience with Putin in the Ukraine crisis has already triggered a fundamental rethink of its bilateral relationship with Russia.
Berlin's policy of "Wandel durch Annaeherung" -- changing Russia by getting closer to it -- was already cracking under Merkel, who has taken a tougher line with Putin than her SPD predecessor Gerhard Schroeder.
Now it is effectively dead, even for many members of the SPD whose attitudes towards Russia were shaped by chancellor Willy Brandt's "Ostpolitik" engagement policy in the 1970s and the crumbling Soviet Union's support for German reunification.
SPD Foreign Minister Frank-Walter Steinmeier, a protege of Schroeder who took office three months ago promising a closer partnership with Russia, has turned into one of the most vocal critics of Moscow in recent weeks.
The tougher stance has moved Berlin closer to Washington at a time when transatlantic ties have been strained by the NSA spying scandal. The only leader Merkel seems to have spoken to as much as Putin since the crisis erupted is Obama, whom she will see next week in the Hague and in Washington in early May.
"The Russians have managed to give this relationship a new sense of direction and purpose," said John Kornblum, U.S. ambassador to Germany under President Bill Clinton.
For the foreseeable future, even leading SPD officials acknowledge, relations with Russia will be reduced to bare economic essentials.
On Wednesday, in one of the strongest signals of Berlin's resolve to date, the SPD-led economy ministry told defence contractor Rheinmetall to put a halt to a two-year old contract to deliver combat simulation gear to Russia.
Already, a debate has begun about how Germany, which receives over a third of its gas and oil from Russia, can reduce its dependence -- a task complicated by Merkel's abrupt phase-out of nuclear energy following the Fukushima disaster in Japan.
"What would really hurt Russia is Germany buying less gas and oil," Michael Fuchs, deputy leader for Merkel's conservatives in parliament, told Reuters. "Even if we reduce it by a few percentage points it will send an important signal."
EU Energy Commissioner Guenther Oettinger, a party ally of Merkel, has said Europe could tap more gas from countries like Norway, Algeria, Nigeria, Libya and the United States, even if it is more expensive.
Behind this tough talk is a more confident Germany.
Back in 2009, when Russia halted gas flows through Ukraine for two weeks, affecting supplies to Europe, Germany was in the midst of its worst recession since World War Two.
Now, after weathering the euro crisis with barely a scratch, there is a widespread sense that Russia would suffer far more from an economic Cold War than Germany, or Europe.
Putin, Merkel seems to be calculating, has much more to lose. (Additional reporting by Luke Baker, Tom Koerkemeier & Martin Santa in Brussels, Matt Spetalnick in Washington, Christian Lowe in Warsaw, Jason Hovet in Prague, Elizabeth Pineau in Paris, William James & Kylie MacLellan in London; Editing by Anna Willard)