Restoring confidence in euro top priority: Germany

German Chancellor Angela Merkel said the euro zone's problems must be tackled at their root, telling a financial conference rules governing the single currency zone should be tightened.

The euro slumped to a four-year low on Wednesday after a unilateral German move to ban naked short selling on some instruments exposed political divisions in Europe and stoked fears of tighter financial regulation.

Naked short selling involves selling a financial instrument without first borrowing the instrument or ensuring that it can be borrowed, as would be done in a conventional short sale.

Underscoring the splits within the European Union, France, still smarting from Germany's failure to consult it on the ban, said it did not agree with Merkel's comment on Wednesday that the euro was under threat.

I absolutely do not think that the euro is in danger, French Economy Minister Christine Lagarde told RTL radio on Thursday. The euro is a solid and credible currency.

Germany is the main EU paymaster in a 110 billion euro bailout with the International Monetary Fund (IMF) of debt-bound Greece and in a $1 trillion safety net for other vulnerable euro zone nations.

But Merkel, forced to ditch an electoral promise of 16 billion euros in tax cuts to fund the rescue packages, is under pressure at home after voters angered by the Greek debt crisis punished her coalition in a key regional vote.

The top priority is to restore confidence in the euro. This will only be achieved if the measures are supplemented by regulation and oversight. There is acute need for action, German Finance Minister Wolfgang Schaeuble said.

IRRATIONAL MARKETS

Markets are also keen to see how the European Union will unwind expansionist monetary policies designed to support economies during the global meltdown, and Merkel called for coordinated action at European level.

The issue of exit strategies is of great importance to us. Quite frankly I am quite concerned about this issue, Merkel said. We will focus on a coordinated exit strategy in Europe.

Jean-Claude Juncker, chairman of the Eurogroup forum of euro zone finance ministers, said the weakness in the euro, down more than 7 percent against the dollar in the past month alone, was likely due to fears that economic growth in the 16 countries that share the currency will slow.

Greece has been forced to impose drastic austerity cuts as the price for the EU bailout, while Spain and Portugal, seen as the markets' next potential targets, have also embarked on painful public spending cuts to rein in their deficits.

Analysts now fear the drive to restore fiscal balances will slow down economies in the European Union just as they recover from the sharp global downturn.

Juncker said markets were acting irrationally.

There is a certain reluctance to believe the Greeks can overcome the current crisis. I don't think the markets are behaving in a rational way, he told Reuters in Tokyo.

Speaking to reporters after meeting Japanese Finance Minister Naoto Kan, he said he did not see the need to take immediate action on the euro's rapid plunge, but that central banks were in close contact.

The euro rebounded late on Wednesday as traders covered short positions on speculation European monetary officials might move to check its rapid fall.

Greeks began a 24 hour general strike on Thursday in protest against the austerity measures demanded by the European Union and the IMF in exchange for the bailout.

China said the euro crisis was adding to global uncertainties, a factor underlined by weakness in stock markets.

The European sovereign debt crisis is a challenge not just for the countries that are party to it, such as Greece. In fact, it is a challenge to the stability of the entire international financial market, said assistant finance minister Zhu Guangyao.

It concerns the recovery of the entire international economy, and so it demands a common response from the international community, he said.

(Additional reporting by Stanley White and Holger Hansen; Writing by Jon Boyle; Editing by Kevin Liffey)