The suspect worked as a female impersonator in a string of cabarets in eastern France and over the border in Germany until he retired in 1992.
The suspected accomplice, a 43-year-old Tunisian, Slim Fezzani, serving a jail term for the murder of a gay insurance agent in 1999, is his former lover, the sources said.
The Tunisian has been moved from a Paris jail to Montbeliard for questioning, deputy state prosecutor Jean-Marc Gervason said.
Most of the murders took place in the eastern French regions of Alsace and Franche-Comte, although three were in the Paris area.
The 18 murders were committed between 1980 and 2000 but Gervason said the current investigation concerned only six killings, which took place between 1983 and 2000.
Of the six victims currently under investigation, one was a woman prostitute and five were men - one was handicapped and another a barman.
Both men deny the accusations, and the prosecution says it has "no formal proof" of their guilt at this stage.
Neighbours in the block of flats in Mulhouse, where the suspect lived with his dog, said they were shocked by his arrest.
"He was such a nice man and now we learn he might be a serial killer," said one. Another said he used to "reach out to people and talk to them".
L'Alsace newspaper said the arrest followed a two-year investigation by a Montbeliard police officer, who spotted the man's name in database files relating to a string of unsolved murders and traced a connection.
The victims were all killed by a violent blow to the head, followed by multiple stabbings. Each time the bodies were found partly naked, but the victims' faces were covered up.
Several other people connected to the two main suspects are also being questioned. Prosecutors were to hold a Press conference today.
Last year police in Mulhouse arrested a 46-year-old homeless man, Yvan Keller, who confessed to 150 murders, mostly elderly women, before committing suicide. Police believe he had killed at least 25 times since 1989.
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