Greece's borrowing costs fell to their lowest level in weeks on Tuesday amid growing expectations that the government will announce new austerity measures this week to secure European financial support.

Prime Minister George Papandreou, who has called a cabinet meeting for Wednesday, is under pressure to meet European Union demands to identify up to 4.8 billion euros ($6.5 billion) in additional savings before he visits Germany on Friday.

Government sources said he was looking at measures such as raising value added tax (VAT), increasing duty on fuel and cutting public sector pay, and could reach a decision after a meeting with members of his PASOK Socialist party later on Tuesday.

There is considerably more confidence now that there will be some form of support mechanism to help Greece, said Kornelius Purps, a strategist at UniCredit in Munich.

However, German Foreign Minister Guido Westerwelle said it was inappropriate to talk about financial aid until Athens had done more to clean up its public finances.

Before there are discussions about aid, we expect Greece to complete its homework on consolidation policy, Westerwelle, who is also vice-chancellor, told reporters.

His liberal Free Democratic Party has led voices opposed to bailing out the highly indebted euro zone country, but his comments did not preclude eventual financial support.

CONTINGENCY PLAN

European government sources have said Germany and France are working on contingency plans involving state-owned financial institutions guaranteeing or buying Greek bonds.

Credit rating agency Moody's said in a research note the reported plan could involve the purchase of about 30 billion euros ($40.67 billion) in Greek debt by French and German state-owned banks, and by private investors.

Details might be announced on Friday when Papandreou meets German Chancellor Angela Merkel in Berlin, it added.

That might give Greece a window to issue a syndicated 10-year bond which the market expects by mid-March, when EU finance ministers will review its progress in cutting the budget deficit by four points to 8.7 percent of gross domestic product this year.

Without waiting for the announcement of more austerity, Greece's main public sector union called a 24-hour strike for March 16 in protest against the new measures, expected to deepen cuts in civil servants' pay and benefits.

Polls show relatively strong support for plans to tackle a crippling 272 billion euro ($368 billion) debt but taxi drivers brought traffic to a halt as they drove through Athens en masse in protest against a tax clampdown.

In Brussels, European Socialists proposed setting up an emergency fund to prevent defaults by euro zone countries such as Greece and ward off a locust swarm of speculators.

The fund would be part of the European Investment Bank (EIB), the European Union's government-owned soft lending arm, which issues bonds to secure cash for projects such as energy and motorway construction.

The current crisis has revealed the lack of a solidarity mechanism in the EU, said former Danish Prime Minister Poul Nyrup Rasmussen, leader of the Party of European Socialists.

However, the EIB said its charter barred it from any role in financial rescues and countries such as Germany, the Netherlands and Finland strongly oppose a bailout fund.

After EU Economic and Monetary Affairs Commissioner Olli Rehn held talks in Athens on Monday, the European Commission declined to say how much more Greece needed to save to achieve its ambitious deficit-cutting target.

Greek sources said EU, European Central Bank and IMF experts had assessed the additional gap at up to 4.8 billion euros in the most pessimistic growth scenario, but Greece has argued that the real shortfall is likely to be much smaller.

The government says a two percentage point increase in VAT to 21 percent would bring in about 2 billion euros in extra revenue, but economic analysts say it would yield only about 1.4 billion because the hike would depress consumption.

If the government were to cancel a 14th month salary payment to public employees, that would save about 1.4 billion euros. However, such a move would be unpopular and might undermine public support for the austerity plan.

Ministers are considering higher taxes on fuel, tobacco, alcohol and luxury goods. A proposed pensions freeze would save about 300 million euros indirectly, but would not count toward reducing this year's deficit.

(Additional reporting by Marcin Grajewski and Jan Strupczewski in Brussels, Dina Kyriakidou and George Georgiopoulos in Athens, Ian Chua in London; writing by Paul Taylor, editing by Andrew Dobbie)

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