US Airways Group Inc said it dropped out of merger talks with United Airlines parent UAL Corp, perhaps clearing the way for UAL and Continental Airlines Inc to combine in what would be the world's largest airline.

UAL and Continental are in talks for a possible stock merger with no premium, a person familiar with the matter said.

Experts believe such a combination would stabilize an embattled airline industry. Indeed, many believe UAL entered talks with US Airways so it could draw Continental, arguably a better match, into separate discussions.

But US Airways' decision to pull out could reduce UAL's negotiating leverage.

"It does create more of a sense of inevitability about United and Continental," said Joe Schwieterman, transportation expert at DePaul University in Chicago. "United can no longer pit one airline against the other and take the best deal."

Spokeswomen for UAL and Continental declined to comment. The person familiar declined to be named because the merger talks are private.

A merger of UAL and Continental would form the world's largest airline, ahead of Delta Air Lines Inc.

Some experts say integrating the two carriers would be easier than merging UAL and US Airways because they have more compatible route structures and labor forces.

Shares of US Airways closed down 2.9 percent at $6.47 on the New York Stock Exchange. UAL shares rose 1.3 percent to $21.71 on Nasdaq. Shares of Continental eased 0.1 percent to $21.43.

Continental also reported a larger-than-expected quarterly loss on Thursday.

Consolidation a Goal
US Airways' announcement was the company's first acknowledgment that it had been in merger talks with UAL, their second in two years.

"After an extensive review and careful consideration, our board of directors has decided to discontinue those discussions," US Airways said. "It remains our belief that consolidation makes sense in an industry as fragmented as ours."

Continental Chief Executive Jeff Smisek declined to discuss the developments in a conference call on the quarterly results.

If the carrier merged with UAL, Smisek would become the combined company's chief executive, while UAL CEO Glenn Tilton would become chairman, the person familiar with the matter said.

Tilton and US Airways Chief Executive Doug Parker are vocal proponents of consolidation for the industry, which they say suffers from overcapacity.

Airlines are struggling to recover from a 2-year downturn triggered by high fuel costs and weak passenger demand.

Some industry experts believe one airline merger could spur others and that several tie-ups of big carriers are possible.

UAL on Thursday maintained that consolidation would help.

"We thoughtfully consider opportunities, based on what's in the best interest of our company, our employees, our customers, our shareholders and the communities we serve," the No.2 U.S. airline said.

UAL also held talks with Continental in 2008. Continental walked away from those discussions and the two airlines later entered into a strategic partnership.

US Airways was formed from a merger of USAir with America West Airlines in 2005. It later failed to complete a hostile takeover of Delta.

The first wave of financial results for 2010 have been mixed. Carriers are reporting improved revenue and effective cost controls, save for stubbornly high fuel expenses.

Airline executives also worry that the slow pace of economic recovery may limit future earnings, despite rising fares and passenger demand.

More immediately, airlines are trying to clear a backlog of millions of passengers stranded last week after a volcanic eruption in Iceland paralysed global air travel.

The International Air Transport Association (IATA) estimates the crisis cost airlines revenues of more than $1.7 billion. (Reuters)