Air France-KLM is in pole position to buy Alitalia, the loss-making airline, after Lufthansa decided not to bid for the Italian carrier.

Lufthansa was expected to join rivals Air Franec-KLM and the Italian airline Air One in making an offer for the part state-owned Alitalia today. However Germany's biggest airline surprised the market by saying that it would not be bidding.

"Taking into respect all information which is known to us at this date, and taking this into account and comparing the pros and cons, we will not submit a bid," a spokeswoman for Lufthansa said.

One concern the German group had was that it would lose its investment grade rating if were to take on Alitalia’s liabilities.

Shares in Air France-KLM soared on the news of Lufthansa's decision, as fears of a fierce bidding war between the French and German flag-carriers evaporated.

Air France-KLM, which already has a cross-shareholding and a commercial alliance with Alitalia, is the clear front-runner in the competition, which has been marred by a series of false starts.

The deadline for bids ends at lunchtime today, with analysts already suggesting that Air France-KLM could probably negotiate attractive financial terms for the struggling airline as its rival in the auction, Air One, is a significantly smaller low-cost operator.

The Italian Government's attempt to auction its 49.9 per cent stake in the airline stalled in July after it set stringent conditions around the sale of the loss-making airline, which deterred buyers.

Air France-KLM refused to take part in the earlier bidding process because of concerns at Alitalia’s willingness to restructure to stem losses and has emphasised that it will not do a deal that harms its own profitability.

The Italian Government is being forced to find a private sector buyer for the airline as the European Union has refused to allow any more state aid to the airline.

In a statement on Thursday, Air France-KLM said it would aim to develop a business plan in line with that drawn up by Maurizio Prato, the chairman of Alitalia. It also attempted to head off potential union opposition to the merger by saying that it would be “counting on the support of the Italian carrier’s entire workforce”.

Jean-Cyril Spinetta, chairman of Air France-KLM, said in the statement: “This major step in European consolidation would not only be beneficial for passengers but would also meet the requirements for the [Air France-KLM] group’s economic and financial stability, including its target of a return on capital employed after tax of 8.5 per cent by the end of fiscal 2009-10.”

Alitalia is hoping to select a preferred bidder by Christmas, but it is thought that could be an optimistic timetable.

The airline has a market value of about €1.1 billion (£792 million) and about €1.2 billion of debt. It loses more than €1 million a day and is frequently hit by strikes from powerful unions.

A deal between Air France-KLM and Alitalia would mark the beginning of an expected wave of consolidation among airlines in Europe, encouraged by the beginning of an "Open Skies" agreement in March.

The introduction of Open Skies will allow any European or US airline to operate out of Heathrow. A number of carriers are positioning themselves to take advantage of this change.

However, the real prize, often mooted but never achieved, of a merger between a European and US carrier is still thought to be some way off.

An offer from tiny Air One, backed by Italy’s biggest retail bank, Intesa Sanpaolo, would keep the flagship in Italian control. However, Romano Prodi, the Italian Prime Minister, said this week that that was a secondary concern.

Alitalia’s lucrative business market – especially its dominance of the route from Rome to the financial capital Milan – remains attractive despite the problems with the rest of the airline.

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