diff --git a/mercurial/bdiff.c b/mercurial/bdiff.c
--- a/mercurial/bdiff.c
+++ b/mercurial/bdiff.c
@@ -240,6 +240,7 @@ static void recurse(struct line *a, stru
 static struct hunklist diff(struct line *a, int an, struct line *b, int bn)
 {
 	struct hunklist l;
+	struct hunk *curr;
 	struct pos *pos;
 	int t;
 
@@ -259,6 +260,30 @@ static struct hunklist diff(struct line 
 	}
 
 	free(pos);
+
+	for (curr = l.base; curr != l.head; curr++) {
+		struct hunk *next = curr+1;
+		int shift = 0;
+
+		if (next == l.head)
+			break;
+
+		if (curr->a2 == next->a1)
+			while (curr->a2+shift < an && curr->b2+shift < bn
+			       && !cmp(a+curr->a2+shift, b+curr->b2+shift))
+				shift++;
+		else if (curr->b2 == next->b1)
+			while (curr->b2+shift < bn && curr->a2+shift < an
+			       && !cmp(b+curr->b2+shift, a+curr->a2+shift))
+				shift++;
+		if (!shift)
+			continue;
+		curr->b2 += shift;
+		next->b1 += shift;
+		curr->a2 += shift;
+		next->a1 += shift;
+	}
+
 	return l;
 }
 
diff --git a/tests/test-bdiff b/tests/test-bdiff
--- a/tests/test-bdiff
+++ b/tests/test-bdiff
@@ -1,6 +1,6 @@
 #!/usr/bin/env python
 
-import sys
+import sys, struct
 from mercurial import bdiff, mpatch
 
 def test1(a, b):
@@ -39,4 +39,16 @@ test("abc", "abc")
 test("a\n", "a\n")
 test("a\nb", "a\nb")
 
+#issue1295
+def showdiff(a, b):
+    bin = bdiff.bdiff(a, b)
+    pos = 0
+    while pos < len(bin):
+        p1, p2, l = struct.unpack(">lll", bin[pos:pos + 12])
+        pos += 12
+        print p1, p2, repr(bin[pos:pos + l])
+        pos += l
+showdiff("x\n\nx\n\nx\n\nx\n\nz\n", "x\n\nx\n\ny\n\nx\n\nx\n\nz\n")
+showdiff("x\n\nx\n\nx\n\nx\n\nz\n", "x\n\nx\n\ny\n\nx\n\ny\n\nx\n\nz\n")
+
 print "done"
diff --git a/tests/test-bdiff.out b/tests/test-bdiff.out
--- a/tests/test-bdiff.out
+++ b/tests/test-bdiff.out
@@ -17,4 +17,7 @@
 *** 'abc' 'abc'
 *** 'a\n' 'a\n'
 *** 'a\nb' 'a\nb'
+6 6 'y\n\n'
+6 6 'y\n\n'
+9 9 'y\n\n'
 done