Uncertainty over an aid package for Greece pushed up its borrowing costs to a 12-year high on Monday, with demands from Germany for further austerity measures before aid is granted heightening the tension.
Greece tried to reassure investors on Sunday that aid would arrive in time to avert the euro zone's first sovereign debt default, despite signs that a 45 billion-euro ($60.49 billion) EU-International Monetary Fund package would have to be bigger.
But the premium investors demand to buy Greek government bonds rather than euro zone benchmark Bunds hit a new 12-year high on Monday because of concern over the implementation of the aid package and the conditions attached.
The market wants to see the cash laying on the table, not in a coffer besides the table, said David Schnautz, strategist at Commerzbank in Frankfurt.
The backing of Germany, Europe's biggest economy, is vital for any aid but Berlin faces public opposition to a financial rescue and is taking a tough line over the terms.
The government has not taken a decision (on aid), German Foreign Minister Guido Westerwelle told reporters at a meeting of European Union ministers in Luxembourg.
That means that the decision can fall in either direction. Offering money too soon would get in the way of Greece doing its homework with the requisite diligence and discipline.
Despite German pressure on Athens, markets kept pressure on Berlin to decide fast by pushing up the cost of insuring Portuguese government debt against default to a record high because of fears that Portugal could be next to debt crisis.
The Greek crisis has started to spread to the rest of the periphery and Portugal seems to be next in line. The situation there is less urgent than in Greece, but the medium-term outlook is challenging, said Darren Williams, senior economist at Alliance Bernstein.
Unless Europe's leaders can draw a line under the situation, Portugal could face an uncomfortable period.
Underlining the fears of contagion to other heavily indebted members of the 16-country euro zone, and also concerns about the damage the crisis could do to the EU's standing, Austria called for a quick decision on triggering aid.
This aid, which is urgently needed, needs to be effective. We should waste no time here, the basic decisions have been made, Foreign Minister Michael Spindelegger said.
AID REQUEST FAILS TO REASSURE INVESTORS
Saddled with huge debt and a swollen deficit, Greece bowed to pressure from financial markets on Friday and formally requested aid, triggering what could be the first financial rescue of a member of the 11-year-old currency bloc.
Athens has already announced billions of euros in budget cuts, including tax hikes and reductions in public sector wages, setting off violent protests and strikes.
Now it is in talks with the EU and IMF on additional steps to get the aid flowing in time to meet a May 19 debt deadline.
Greek Finance Minister George Papaconstantinou said on Sunday talks with the IMF and the European partners went well and he was confident Athens would secure help in May to finance its public debt.
Papaconstantinou also played down concerns that the German government, which wants to avoid defeat in an important regional election on May 9, might block the rescue deal.
IMF Managing Director Dominique Strauss-Kahn, whose organization is expected to provide one-third of the aid, said aid talks had accelerated but Canadian Finance Minister Jim Flaherty said the package would end up being more than had been said previously.
Asked by a reporter whether aid could be as much as 80 or 90 billion euros, Papaconstantinou said he could not provide specific figures.
Investors' concerns were not appeased.
An EU-IMF support package of 45 billion euros would only fill liquidity needs of the first year. A multi-year package of 90 billion euros could provide Greece the breathing space to implement the fiscal adjustment, Barclays Capital said.
The Greek/German 10-year bond yield spread climbed to 614 basis points, up from Friday's settlement close of 588 bps matching levels last seen in February 1998. Greek banks stocks also fell, by 4.0 percent.
Spreads against Bunds widened across the euro zone periphery, with the Italian spread moving to 99 bps, its widest since July 2009.
Greece needs 30-40 billion (euros) this year. They need the same amount for each of the following two years. The aid is very much a stop-gap and it's far from certain that everyone is going to support it, said Nigel Rendell, an emerging markets strategist at RBC.
Moody's said the conditions the EU and the IMF attach to their aid to Greece would be important factors in its review of the country's rating, which the firm cut last week.
Greece's government bond rating has factored in the assumption that conditional support from the EU and/or the IMF would be forthcoming, if it was deemed necessary, Sarah Carlson, Moody's lead analyst for Greece, told Reuters.
(Additional reporting by George Georgiopoulos and Ingrid Melander in Athens, Emelia Sithole-Matarise in London; writing by Timothy Heritage, editing by Toby Chopra)