The Greek parliament prepared to adopt a harsh austerity plan on Thursday in the face of violent unrest, as markets looked to the European Central Bank to prevent a debt crisis engulfing the euro zone.
The euro and world stocks fell for a third day as investors fled risk amid signs that Athens' woes are spreading to other weak euro economies, testing whether European governments are willing to extend a bailout devised for Greece alone.
The cost of insuring Portuguese and Spanish debt as well as Greek debt against default leapt to new peaks before a closely watched auction of 5-year Spanish bonds. Yields jumped for the auction but there was no shortage of demand.
Policymakers' attempts to talk down the risk of contagion and scare off speculators had little impact on traders unimpressed by the slow EU response to the crisis.
There's no let-up in concerns that the euro zone debt crisis could continue to worsen and as a result equity markets across the globe remain under pressure, said Ben Potter, analyst at IG Markets.
German Finance Minister Wolfgang Schaeuble said any restructuring of Greek debt would cause exactly the kind of conflagration that we could no longer control.
We are in a really fundamental crisis, the stability of the euro is really at stake, he added.
All eyes were on ECB President Jean-Claude Trichet to signal what the world's second most powerful central bank can do to pull the euro zone out of a vicious cycle of soaring borrowing costs, dwindling growth prospects and sovereign debt downgrades.
Trichet will face questions on whether the ECB may reverse its policy and buy euro zone government bonds or try other measures to keep credit markets open to Portugal and Spain at affordable rates while Greece receives EU/IMF emergency loans.
European Council President Herman van Rompuy, who will chair a euro zone summit on the crisis on Friday, was the latest top EU official to try to erect a verbal firewall, saying the situation of Portugal or Spain had nothing to do with Greece.
What I now see are totally irrational movements on the markets set off by unsubstantiated rumors, for instance yesterday with Spain, but also as regards Portugal, he said.
Ratings agency Standard & Poor's said it could not comment on market speculation it would downgrade Italy. The spread between Italian and German benchmark 10-year bonds widened earlier on Thursday to around 130 basis points.
The Greek government vowed not to retreat a single step from unpopular wage and pensions cuts and tax rises despite violence in Athens that claimed three lives on Wednesday when rioters set fire to a bank and fought running battles with police.
We will press ahead, even if we have to walk alone, without the backing of other parties, Finance Minister George Papaconstantinou told parliament.
The Socialist government has a comfortable majority but the main conservative opposition party has vowed to vote against the austerity bill, dashing hopes of political consensus which analysts said would have improved the chances of implementation.
Greek newspapers condemned the violence but some said it was now up to Greece's leaders to set a course people could follow.
Whether we self-destruct, whether we go bankrupt, depends now on our leaders, but also on all of us, said center-right daily Kathimerini.
The country's main public sector union ADEDY and private sector union GSEE planned to demonstrate outside parliament ahead of the expected vote late on Thursday on the bill. It is designed to save an extra 30 billion euros to reduce a bloated deficit that stood at 13.6 percent of economic output in 2009.
The euro sank to its lowest level in 14 months, below $1.28. It has fallen 10 percent since the start of the year as Greece's fiscal troubles escalated.
Concern that Greece will be unable to make all of the deep budget cuts agreed on Sunday with the EU and IMF because of social unrest is one of the drivers of the euro zone turmoil.
European Commission President Jose Manuel Barroso, speaking by video link to a conference in Berlin as the German parliament deliberated on the Greek rescue, said he was sure all 16 euro zone countries would approve the loan package.
He warned there would be a negative impact on the whole euro area unless there was a unanimous decision in support of aid. German Vice-Chancellor Guido Westerwelle, whose pro-business FDP party has been critical of helping Greece, said Germany was on track for a broad parliamentary majority in favor of the plan.
Chancellor Angela Merkel has said the success of the package will determine nothing less than the future of Europe -- and with it the future of Germany in Europe. Support for the plan is accompanied by calls for a new discipline in the euro zone.
Westerwelle said the best punishment for states with excessive budget deficits would be to cut off payments from EU funds. Slovenia called for rules allowing the EU to exclude a state that breached the bloc's stability pact.
Troubles in the eurozone drove U.S. treasury debt prices higher as investors fled to safe havens, including gold and the dollar, worried the crisis could cross the Atlantic and thwart the U.S. recovery.
(Additional reporting by Noah Barkin in Athens, Gernot Heller in Berlin, Tim Heritage in Brussels and George Matlock in London; writing by Paul Taylor/Andrew Roche; editing by Janet McBride)