Chaos over Greece's role in the euro zone battered equity markets and hit the euro Thursday, swamping any residual support from the U.S. Federal Reserve's soothing comments less than 24 hours earlier.

The threat of a Greek exit from the euro hung over a meeting of G20 leaders after France and Germany made it clear that Athens must decide urgently whether it wants to stay in the 12-year-old currency bloc.

Greek Prime Minister George Papandreou was under the gun, losing support within his own party, after calling for a referendum which will test his highly indebted country's resolve to stay in the currency bloc.

For investors, it has raised the specter of a disorderly default on Greek debt with the real threat being a spillover into other countries, notably Italy.

There is massive uncertainty. Is Greece going to come out of the euro? said Andrea Williams. who manages $2.1 billion in assets for Royal London Asset Management.

We are trying to avoid exposure to domestic Europe, we were concerned about European growth anyway, but now it is going to be absolutely dreadful. We are trying to avoid anything with over exposure to Italy and Spain.

World stocks as measured by MSCI were down 0.7 percent with emerging markets falling 1.6 percent.

In Europe, the FTSEurofirst 300 <.FTEU3> lost 1 percent. Earlier, Japan's Nikkei <.N225> closed down 2.2 percent.

The renewed Greek crisis, beginning only days after a supposedly comprehensive European Union agreement to fix the debt problem, has brought a gradually improving investment climate to a sudden halt.

This includes soothing words from Fed Chairman Ben Bernanke on Wednesday, promising to do more, if necessary, to boost the U.S. economy.

EURO HIT

The euro fell and looked set for further losses as a result of the uncertainty about Greece remaining in the bloc.

It was still, however, at $1.37, boosted by repatriation flows. But the trend was negative.

Depending on whether there is a referendum or not I would not be surprised to see the euro trade down to the $1.33/$1.34 area in the next two to three weeks, said Jeremy Stretch, currency strategist at CIBC.

The premiums investors have to pay to hold Italian and French 10-year government debt over benchmark German Bunds rose to their highest in the euro era.

The French/German 10-year bond yield spread was last 8 basis points wider on the day at 135 bps, ahead of a planned sale of up to 7 billion euros worth of bonds. The equivalent Italian/German spread hit its widest levels since 1995 at 462 bps, up 24 bps on the day.

(Additional reporting by Jessica Mortimer and Joanne Frearson; editing by Anna Willard)