Markets pounded Greek bonds and banking stocks on Thursday, driving the debt-stricken euro zone member's borrowing costs to new highs and pushing it closer to tapping a last resort EU/IMF safety net.

The government struggled to reassure markets it can stay solvent after the premium that investors demand to buy Greek debt rather than the benchmark German government debt surged for the third day in a row to the highest level since Greece joined the euro.

Skepticism over a dearth of details surrounding a proposed European Union and International Monetary Fund lifeline continued to pile pressure on a country already struggling to cover its wide fiscal gap and huge public debt load.

Despite everything the EU and the euro zone have done, there is still a lack of clarity (and) confusion about what they intend to do, when they intend do it and how much would be involved, Chris Pryce, senior Greece analyst for rating agency Fitch, told Reuters.

It is now up to the Greek government to go publicly to the EU and IMF and ask for the cash and the support.

Euro zone deputy finance ministers and central bankers were likely to discuss the terms on which emergency loans could be extended to Athens later on Thursday, a euro zone source said.

Greece's government has pledged to cut its public finance deficit by almost one-third to 8.7 percent of gross domestic product this year, but is wary of sparking public unrest after a string of riots and strikes since last year.

AVOIDING SAFETY NET

Reluctant to give in to the pressures, Greece insists it prefers to borrow from markets and will use the European Union/International Monetary Fund safety net agreed only as a last resort, a call it repeated on Thursday.

For the time being it is not necessary to activate the aid mechanism, said spokesman George Petalotis, adding Athens was striving not to borrow at barbaric interest rates.

The 10-year Greek/German government yield spread spiked almost half a percentage point to as much as 463 basis points on Thursday. Two-year government bond yields surged over 100 bps to almost 8 percent.

Germany, which can veto Athens' access to the aid package, also held firm on its position that it is only a last ditch option, with a spokesman saying that, despite the jump in borrowing costs, the government's position remains unchanged.

Dealing with its own financial problems as a local election looms, Berlin has been loath to set a bad example for other euro zone offenders by letting Greece off the hook too lightly.

The euro zone source said euro zone officials had had a convergence of views and the terms should be similar to IMF financing conditions and terms agreed by EU governments.

Another source said the rate of interest should not be higher than 300 basis points over comparable German debt.

Greece's woes drove the euro close to its 2009 low against the dollar on Thursday. It slipped 0.2 percent to $1.3306 at 1227 GMT, just off its 2010 low of $1.3267, though rebounded after reassuring remarks by the head of the European Central Bank, Jean-Claude Trichet..

A Reuters poll showed 64 strategists saw the crisis eroding the euro further to $1.30 in a year's time.

NO DEFAULT SEEN

Greek Economy Minister Louka Katseli said there was no chance at all that Greece will default and markets were testing Athens' ability to finance itself and profiting on price swings.

Her comments on the prospect of default echoed those of Trichet, who said default was not an issue for Greece after the ECB left rates flat at 1 percent and prolonged rules allowing Greek debt to be used as collateral for cheap central bank cash.

The next main challenge Greece faces is to borrow 11 billion euros by the end of May to roll over debt and cover spending.

Three bonds worth 18 billion euros have performed badly this year in the secondary market, and analysts and investors say a dollar bond planned for April and May will struggle to draw demand at the 7 percent yield seen attractive by the government.

Banks, which have asked to tap 17 billion euros remaining in a crisis support package, saw shares tumble more than 7 percent before retreating to close 6 percent lower.

They have been hit by deterioration of the state bonds they hold and a rise in non-performing loans, and media have reported foreign banks have stopped taking part in interbank activity, squeezing Greek lenders' ability to roll over short-term loans.

They are down 50 percent since worries over how Greece will cut a debt pile that exceeds its annual economic output by a fifth started to rattle investors in mid-October, wiping out about 24 billion euros ($32 billion) in market capitalization.

Also causing worry were new ECB rules announced on Thursday on extending easier lending terms for holders of Greek government bonds into 2011. The rules defuse the danger of Greek debt falling off the list of what banks can swap for ECB loans next year if it faces more ratings downgrades.

(Additional reporting by Lefteris Papadimas and Harry Papachristou in Athens, Jan Strupczewski and Julien Toyer in Brussels, Sakari Suoninen and Marc Jones in Frankfurt; writing by Michael Winfrey; Editing by Stephen Nisbet and Leslie Adler)