Governments around the world sought on Friday to calm financial markets hit by fears that Greece's debt crisis could cause turmoil in other European economies.

Group of Seven finance ministers discussed the debt problems in a conference call after Federal Reserve officials expressed concern and President Barack Obama told German Chancellor Angela Merkel by telephone that he backed efforts to rescue Greece.

We agreed on the importance of a strong policy response by the affected countries and a strong financial response from the international community, Obama said.

He said U.S. regulatory agencies were investigating a sudden drop on U.S. markets on Thursday, which he called unusual market activity, and would recommend appropriate action.

Obama and Merkel spoke before euro zone leaders began arriving for a summit to put their political stamp of approval on the EU-IMF deal to release 110 billion euros over three years to help Greece overcome its debt and deficit crisis.

Merkel said they would also discuss accelerating measures to tighten financial regulation to prevent such crises in the future and that all 16 countries that use the euro must abide by rules on fiscal targets such as national debt and deficits.

The German parliament approved its share of the Greek rescue, the largest contribution by any of the euro zone countries, and the Dutch parliament is part of the deal. Italy's cabinet has also given initial approval.

But in a potential obstacle to the financial assistance, five German academics filed a legal challenge to the package, reflecting widespread German public opposition to the measure.

BATTLE BETWEEN MARKETS AND GOVERNMENTS

Merkel talked of a battle between governments and markets, and EU monetary affairs chief Olli Rehn compared Greek insolvency to the financial crisis 18 months ago.

Little did authorities of the United States know in September 2008 what the bankruptcy of investment bank Lehman Brothers would lead to, Rehn wrote in a Finnish magazine.

The consequence was that the world's financial system was paralyzed in a way that led to the biggest global recession since the 1930s. Consequences from Greece's insolvency would be similar if not worse.

French Prime Minister Francois Fillon said the action to save Greece would defeat and put an end to speculation which has been unleashed against this country, and there was no reason for markets to take aim at indebted Spain and Portugal.

The European Central Bank was to hold a conference call with commercial banks to gather opinions on the state of money markets.

Euribor bank-to-bank lending rates reached their highest level in almost four months and world stocks held near a three-month low, despite strong U.S. jobs data.

The euro traded close to a one-year trough, weighed down by persistent fears over the Greek crisis.

The market volatility could prompt China to move more slowly than expected to let the yuan appreciate, foreign exchange strategists said.

NO ALTERNATIVE TO EURO

German Finance Minister Wolfgang Schaeuble told parliament aid to Greece would uphold Germany's postwar legacy of serving peace, 65 years after its darkest chapter in World War Two.

The joint European currency, the joint European economic area were right, he said. There is no comparable alternative to them in the 21st Century in the age of globalization. That is why we must defend the joint European currency.

The Greek parliament backed an austerity plan on Thursday, but selling accelerated across markets overnight after the European Central Bank said it had not considered buying government bonds to ease Greece's debt crisis. Some investors had hoped it would be more active in calming markets.

European investment-grade corporate credit default swaps hit their widest levels in over a year, and there was a rise in the premium that investors demand to buy peripheral euro government bonds rather than benchmark Bunds.

The panic trading that started today again is fading slightly but things remain quite vulnerable, said Patrick Jacq, euro zone interest rate strategist at BNP Paribas.

CREDIBILITY OR SLOW DEATH?

Greece's 30 billion euro ($40 billion) austerity bill imposes years of hard measures in return for the joint rescue by the European Union and the International Monetary Fund.

After violent protests in Athens, one Greek newspaper praised the parliament vote as the politics of credibility. But another daily called the plan a slow death contract.

If it turns out that the economy is not able to withstand the measures, if growth falls much more than forecast there could be social unrest, forcing the government to consider alternative moves in its asset-liability management, said RBS economist Silvio Beruzzo.

This may include restructuring.

ECB chief Jean-Claude Trichet dismissed the prospect of any euro zone debt default.

Default is, for me, out of the question, he said.

(Additional reporting by Noah Barkin in Athens, Gernot Heller in Berlin, Tim Heritage in Brussels, George Matlock in London, Pedro Nicolaci da Costa in Richmond, Virginia; writing by Andrew Roche and Timothy Heritage; editing by Jon Boyle)

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