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Officials try to reassure markets on euro stability

European policymakers scrambled Friday to reassure markets about the stability of the 16-nation currency bloc as investors shed euro assets for a second day and Portugal backed a law that may push its swollen deficit higher.

European Central Bank Governing Council member Ewald Nowotny called talk of a euro zone breakup "absurd" and tried to play down the sharp fall in the euro, which hit its lowest level against the dollar since May 2009.

Greek Prime Minister George Papandreou, on a visit to India, promised to "credibly apply" an austerity program designed to bring his country's yawning debt and deficit under control.

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But worries about Portugal mounted after its opposition-led parliament defied the Socialist government and approved a bill on regional finances that could complicate the country's budget consolidation drive.

Greece, Portugal and other bloc members with swollen deficits like Spain face intense pressure to get their public finances in order and calm markets worried about the risks of a sovereign default.

In the deepest crisis in the zone's 11-year history, analysts are no longer discounting the possibility that a smaller member such as Greece could be pushed out, though most believe monetary union will survive.

"The market is closely watching each country's ability to pay its debts," said Erkki Liikanen, who sits on the ECB council with Mr. Nowotny. "If the faith is lost, rates will go up significantly."

The euro tumbled below $1.36 (U.S.) and slumped versus other safe-haven currencies like the Swiss franc, forcing the Swiss National Bank (SNB) to take the unusual step of intervening in the market.

The cost of insuring Greek, Portuguese and Spanish government debt against default shot to record highs in early volatile trading and the premiums investors demand to buy euro zone government bonds other than liquid German benchmarks rose strongly in the morning before easing somewhat.

Greek stocks fell 3.7 per cent, while Portuguese and Spanish share markets, which had fallen 5 to 6 per cent on Thursday, were down just over 1 per cent.

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In a positive sign for the currency bloc, investors said the market gyrations were mainly the work of short-term speculators and did not reflect a fundamental rethink about euro-denominated assets. Fund flow data showed a small net inflow into European equity funds in the week to Feb. 3.

"We don't see any fundamental moves at all. It's purely speculative," said Patrick Smith, senior investment manager at Santander Asset Management.

But the passing of the Portuguese financing law could fan concern in the markets about the ability of euro zone governments to take the tough steps necessary to bring their finances under control.

The government decried the measure as "wasteful" and vowed to challenge its constitutionality in court.

In central Lisbon, several thousand public administration workers marched to the finance ministry to protest a freeze in public sector wages - one of the main fiscal consolidation steps in the draft budget for 2010.

"There is political risk in Portugal. As long as we don't have positive news on that front, the negative trend in the market will continue," said Jose Gabriel, a trader with Probolsa brokerage in Lisbon.

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Like Portugal, Greece is struggling to convince investors its austerity program is credible. It has pledged to reduce its budget deficit to 8.7 per cent of GDP this year from 12.7 per cent in 2009 through welfare spending cuts, tax hikes and cuts in public sector wages.

"Greece has taken an important step in the right direction," ECB Executive Board member Juergen Stark told German radio.

Markets remain sceptical, however, partly because of the mounting threat of social unrest in a country with a history of violent protest.

In a positive sign, Greek farmers began lifting some road blocks on Friday after a 20-day protest to demand higher prices for their goods. But tax and customs inspectors walked out for a second day and a wider public sector strike is scheduled for next week.

The threat of unrest has also risen in Spain, where criticism of Prime Minister Jose Luis Rodriguez Zapatero is on the rise.

Spanish unions have vowed to stage protests of their own and the opposition has threatened to hold a vote of no confidence in parliament -- which could topple the government if successful.

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