European policymakers defended budget austerity plans on Thursday ahead of a G20 summit set to pit calls for fiscal restraint against warnings that heavy cost-cutting threatens recovery.

European Central Bank President Jean-Claude Trichet said it was wrong to claim that budget austerity would cause stagnation, and German Chancellor Angela Merkel said her country would stick to plans to save 80 billion euros in the next four years, its biggest program of fiscal cutbacks since World War Two.

We'll enact the measures that we've agreed upon, Merkel said in an interview with German ARD television broadcast on Thursday morning. I believe we should not let up.

After winning plaudits for guiding the world economy through the financial crisis, splits have emerged among Group of 20 powers over which policy priority ought to take precedence now -- supporting still-shaky growth or shrinking budget deficits.

Markets remain jittery about the debt crisis and the risk of an economic slowdown in the run-up to the meeting of G20 leaders this weekend, with the cost of protecting government debt against default hitting a record high for Greece and jumping in other peripheral countries such as Portugal.

The draft version of the Toronto summit communique, obtained by Reuters and dated June 11, said the recovery was uneven and fragile and warned against complacency.

Fiscal challenges in many states are creating market volatility, and could seriously threaten the recovery and weaken prospects for long-term growth, it said.

The United States has warned against withdrawing support too soon, mindful of when the government slammed the brakes on spending in the 1930s, prolonging the Great Depression.

But Europe is set on a different path. A market backlash against countries seen to be dragging their feet on cutting debt and deficits has sparked budget cutbacks all over Europe as governments try to rein in spending.

French unions staged a nationwide strike on Thursday over plans to reform the pension system following similar protests in Spain and Greece, where ministers were due to meet on Thursday to discuss their own pension reforms.

Spanish Economy Minister Elena Salgado said she was confident the minority government's budget would pass the national parliament in September, when unions have also scheduled a general strike.

ECB SAYS AUSTERITY GOOD

G20 leaders must also forge consensus on how to harmonize financial regulatory reforms and ECB chief Trichet said he was confident the G20 was on the right track.

But Europe's efforts to present a united front on regulation hit a roadblock on Thursday when EU lawmakers and diplomats failed to agree on new hedge fundrules.

In an interview with Italy's La Repubblica newspaper, Trichet rejected any threat to growth from austerity steps and urged governments to push on with budget and structural reforms.

As regards the economy, the idea that austerity measures could trigger stagnation is incorrect, he said, describing the German budget plans as good and repeating calls for more fiscal discipline in the 16-nation euro zone.

I firmly believe that in the current circumstances, confidence-inspiring policies will foster and not hamper economic recovery, because confidence is the key factor today, he said.

German Finance Minister Wolfgang Schaeuble said he could not understand criticism from abroad that Germany was wrecking the recovery with austerity measures because Berlin is doing a lot to stimulate growth.

There is an implicit accusation that we're not living up to our international responsibilities as far as economic policies are concerned, Schaeuble wrote in a guest column for the Handelsblatt newspaper.

I cannot understand this argument because Germany has taken sweeping measures since 2008 to stabilize the economy. We've done that on top of all the automatic stabilizers we have (such as higher social welfare spending) that play a much smaller role in countries from which we're now being criticized.

Schaeuble pointed to Germany's budget deficit climbing to five percent of gross domestic product (GDP) as evidence of its commitment to growth-boosting measures and said the first consolidation measures won't take effect until 2011.

The G20 groups the world's biggest economies and covers two-thirds of the world's population. It includes Australia, Argentina, Brazil, Indonesia, Japan, Mexico, Russia, South Korea, Saudi Arabia, South Africa and Turkey in addition to the big European economies, the United States and Canada.

(Additional reporting by Nigel Davies in Madrid and Sakari Suoninen in Frankfurt, writing by Krista Hughes, editing by Mike Peacock)

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