EU tells Greece to do more on budget, markets improve

ATHENS (Reuters) - The European Union urged Greece on Monday to take extra austerity measures within days to tackle a debt crisis that has shaken the euro zone and promised to help Athens overcome the problem.

EU Economic and Monetary Affairs Commissioner Olli Rehn made the call after talks with Greek officials amid growing market expectations of a trade-off between new deficit-cutting steps and practical EU support for Greek borrowing.

"I'm sure that together we shall overcome these formidable economic and fiscal challenges," Rehn said after meeting Finance Minister George Papaconstantinou. [nATH005236]

"I want to encourage the Greek authorities to consider and announce additional measures in the coming days to meet this target," he said.

Prime Minister George Papandreou appeared to be preparing the nation for more sacrifices in broadcast remarks to the cabinet dramatizing the crisis and appealing for public support. His labor minister proposed a freeze on pensions this year as one measure to contain spending.

"Today we ask Greek men and women to enlist in our common cause to save our country and the overwhelming majority of our citizens are willing to do it despite the price and despite the burden ... Everybody says yes," Papandreou said.

He has a potentially crucial meeting in Berlin on Friday with Chancellor Angela Merkel of Germany, which is Europe's biggest economy and holds the key to any financial support.

A German government spokeswoman maintained it was up to Greece to pursue budget consolidation to win the confidence of markets and said that Berlin had nothing new to report on the issue of possible steps to support Greek debt.

Greece's borrowing costs tumbled to their lowest level since mid-February on expectations the government will agree soon on new tax rises and spending cuts to plug a budget gap which EU experts say has grown due to a lingering recession.

That in turn may trigger tangible EU support for Greece's effort to borrow or refinance about 25 billion euros ($33.97 billion) by late May, possibly through public guarantees of banks' purchases of Greek sovereign bonds, EU officials and German lawmakers said.

"We seem to be getting closer to a deal on Greece in some shape or form," said Nomura rate strategist Sean Maloney.

EXTRA MEASURES

Even with Monday's slight easing, Greece is still having to pay more than 3 percentage points on top of German bond yields to borrow on capital markets.

European officials and regulators stepped up moves to deter speculation against Greek debt. Germany's financial watchdog has taken steps to identify speculators and ensure they do not profit unduly from any rescue of Greece, a source with direct knowledge of the matter told Reuters.

Greek bank shares rose by 4 percent on hopes of a deal. Fellow euro zone southern rim countries Portugal, Spain and Italy also saw their debt spreads over benchmark German bonds narrow.

Rehn and European Central Bank chief economist Juergen Stark, a stickler for fiscal discipline, held talks with Greek leaders on additional steps to slash Greece's deficit by 4 percent of gross domestic product this year to 8.7 percent.

The Socialist government has already announced two waves of deficit-cutting measures, including a pay freeze and cuts in income supplements in the public sector, tax rises, a crackdown on tax evasion, higher fuel duty and public spending cuts.

But Papandreou, whose approval ratings remain high despite a 24-hour general strike against his austerity plan last week, has promised extra measures if needed to achieve the deficit target.

Among measures under consideration are an increase in Value Added Tax, a luxury goods tax, a further fuel duty hike, a freeze in public sector pensions and possible further cuts in state spending, Greek officials said.

The executive European Commission is due to give an interim report on implementation of the Greek fiscal consolidation plan to EU finance ministers on March 16.

In parallel, discreet talks are going on among euro zone governments on possible mechanisms to support Greece if necessary on the international bond markets, EU sources say.

Merkel, who faces strong opposition at home to any aid for Greece, stressed in a TV interview on Sunday that no decision had been taken and that Greece must put its own house in order.

Saying the euro was in the most difficult phase since its creation, she noted the "no bailout" clause in the EU treaty but did not explicitly rule out the possibility of guaranteeing Greek debt through state-owned institutions.

Greek bonds have been under attack since the new government revealed in October that the 2009 budget deficit would hit 12.7 percent of GDP, more than twice its predecessor's forecast and four times the EU ceiling.

Some of those attacks have involved hedge funds and investment banks using the volatile and unregulated credit default swaps (CDS) market to buy insurance against the risk of a default or debt restructuring, traders say.

"If the Greeks hold on to the strict parameters and the markets continue to speculate against Greece, we will not let them just march through," the head of the Eurogroup of finance ministers said in an interview published on Monday.

Luxembourg Prime Minister Jean-Claude Juncker would not say exactly how the EU might combat speculators but told the German business daily Handelsblatt: "We have the torture equipment in the cellar, and we will show them if needed."

French Economy Minister Christine Lagarde said on Sunday that derivatives on sovereign debt such as CDS should be either tightly regulated, limited or banned.

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