European policymakers scrambled on Friday to reassure markets about the stability of the 16-nation currency bloc as investors shed euro assets for a second day and Portugal backed a law that may push its swollen deficit higher.
European Central Bank Governing Council member Ewald Nowotny tried to play down a sharp fall in the euro, which hit its lowest level against the dollar since May 2009, and called talk of a euro zone breakup "absurd."
Greek Prime Minister George Papandreou, on a visit to India, promised to "credibly apply" an austerity program designed to bring his country's yawning debt and deficit under control.
But worries about Portugal mounted after its opposition-led parliament defied the Socialist government and approved a bill on regional finances that could complicate the country's budget consolidation drive.
Greece, Portugal and other bloc members with swollen deficits like Spain face intense pressure to get their public finances in order and calm markets worried about the risks of a sovereign default.
In the deepest crisis in the zone's 11-year history, analysts are no longer discounting the possibility that a smaller member such as Greece could be pushed out, though most believe monetary union will survive.
"The market is closely watching each country's ability to pay its debts," said Erkki Liikanen, who sits on the ECB council with Nowotny. "If the faith is lost, rates will go up significantly.
The euro tumbled below $1.37 and slumped against other safe-haven currencies like the Swiss franc, forcing the Swiss National Bank (SNB) to take the unusual step of intervening in the market.
The cost of insuring Greek, Portuguese and Spanish government debt against default shot to record highs in volatile trading and the premiums investors demand to buy euro zone government bonds other than liquid German benchmarks rose strongly in the morning before easing somewhat.
Greek stocks were down 3.7 percent by mid-afternoon, while Portuguese and Spanish share markets, which had fallen 5 to 6 percent on Thursday, were down 1 to 2 percent.
In a positive sign for the currency bloc, investors said the market gyrations were mainly the work of short-term speculators and did not reflect a fundamental rethink about euro-denominated assets. Fund flow data showed a small net inflow into European equity funds in the week to Feb. 3.
"We don't see any fundamental moves at all. It's purely speculative," said Patrick Smith, senior investment manager at Santander Asset Management.
But the passing of the Portuguese financing law could fan concern in the markets about the ability of euro zone governments to take the tough steps necessary to reassure investors about the integrity of the bloc.
Like Portugal, Greece is struggling to convince investors that its austerity program is credible.
It has pledged to reduce its budget deficit to 8.7 percent of GDP this year from 12.7 percent in 2009 — a target the European Commission has described as ambitious but feasible.
Markets are skeptical, however, particularly given the mounting threat of social unrest in a country with a history of violent protest.
"I can understand the doubts but that's why we have to prove (ourselves). We will credibly apply this program," Prime Minister Papandreou said in New Delhi.
Greek farmers began lifting some road blocks on Friday after a 20-day protest to demand higher prices for their goods, but tax and customs inspectors walked off the job for a second day and a wider public sector strike is scheduled for Feb. 10.
France's Le Monde newspaper reported that experts from the International Monetary Fund (IMF) estimated it would cost $20-25 billion to pay for a convincing bailout of Greece.
IMF head Dominique Strauss-Kahn said on Thursday that the lender stood ready to help Greece if asked, but Athens has said it can cope without aid and some euro zone leaders want the bloc to solve its problems without resorting to outside support.
The threat of unrest has also risen in Spain, where criticism of Prime Minister Jose Luis Rodriguez Zapatero is on the rise. Spanish unions have vowed to stage protests of their own and the opposition has threatened to hold a vote of no confidence in parliament — a step which could topple the government if successful.
The government was due to detail a series of labor reforms on Friday. Unemployment in Spain, whose economy has slumped since the bursting of a construction bubble, is nearing 20 percent and the Bank of Spain said on Friday that GDP fell 3.6 percent in 2009, the steepest drop in decades.
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