(Reuters) - Greece and its private creditors made progress Thursday in talks on restructuring its debt, both sides said, and they will continue negotiating on Friday with the aim of sealing an agreement within a few days.

Athens needs a deal quickly to avert a chaotic default when a major bond redemption comes due in March. Greece's creditors are demanding that the European Central Bank contribute to a deal to put the country's messy finances back on track.

The talks focused on legal and technical issues and progress was made. They will continue on Friday and probably on Saturday too, a senior Greek government official told Reuters on condition of anonymity.

We aim to conclude the deal very soon.

The Institute of International Finance, which leads talks on behalf of creditors, similarly cited progress and said work would continue Friday. Neither side disclosed any details.

After weeks of wrangling over the coupon, or interest rate, Greece must pay on new bonds it will swap for existing debt, attention has shifted to whether the ECB and other public creditors will follow private bondholders in swallowing losses.

A day after International Monetary Fund chief Christine Lagarde said the ECB may need to accept losses on its Greek holdings, the European Union's top economic official also warned more public money will be needed to make up a shortfall in the country's second bailout.

EU Economic and Monetary Affairs Commissioner Olli Rehn told Reuters there is likely to be some increased need of official sector funding, but not anything dramatic. It was the first time a top EU official had said more public money than a planned 130 billion euro package would be required to rescue Greece.

Private bondholders have added to the pressure by insisting that others who bought bonds, and in particular the ECB, which is Athens' single biggest creditor, take part in the bond swap.

The swap, also known as the Private Sector Involvement, is aimed at slashing Greece's debt by getting creditors to write down their holdings by 50 percent nominally. Real losses are expected to be higher, depending on the terms involved.

It would be outrageous if the ECB doesn't take part in the PSI as keeping their Greek bonds to maturity would allow them to make a profit, while everybody else is taking 70 percent (losses) or even more, one source close to the talks said.

The IIF wants public sector officials to be more decisive in negotiations over Greek debt, the bank lobby group's chairman and Deutsche Bank CEO Josef Ackermann told CNBC.

The ECB, which owns roughly 40 billion euros worth of Greek bonds, is no closer to agreeing on whether or not it will take losses on the Greek bonds it owns after a late night Wednesday meeting, euro zone central bank sources told Reuters.

Either way, a debt deal at the very latest must be clinched a month before 14.5 billion euros of bond redemptions fall due on March 20, the first source said, i.e., in just over three weeks.

If a deal is not reached by then, Greece could sink into an uncontrolled default that would trigger a banking crisis spreading contagion through the euro zone, though the ECB's creation of nearly half a trillion euros of three-year money for the banks in December has tempered that fear.

Debt-laden Italy saw its government bond yields and the cost of insuring against a default fall on Thursday, helped by solid demand for short-term debt at an auction.

COUPON STUMBLE

So far the coupon on the new bonds had been the main stumbling block in the negotiations.

On Monday, euro zone ministers rejected the creditors' offer of a 4 percent coupon on new bonds after Greece and its EU/IMF lenders held out for a 3.5 percent interest rate. They want the lower coupon to ensure the country's debt falls to a target of 120 percent of GDP by 2020, from around 160 percent now.

A second source familiar with the negotiations said the coupon is parked for current time until we can get closer on detail of the overall package. Asked if that would include the ECB, the source said: We would expect it to, still to be determined though.

Greek bankers and government officials said they had not heard of any new proposal from creditors, after local media reported they were willing to improve their final offer of a 4 percent interest rate on the new bonds to about 3.75 percent.

One Greek daily, Kerdos, said participation of public sector creditors including the ECB in the swap deal was a pre-condition for that offer.

Until last week, we knew that the steering committee was authorized to concede up to 3.8 percent for the average coupon, one senior Greek banker told Reuters.

But things are once again up in the air. You have to deal with politicians and 15 different governments asking for different things.

Exact details of Friday's meetings have yet to be scheduled, after IIF chief Charles Dallara left a meeting with Prime Minister Lucas Papademos late on Thursday.

Earlier, German Chancellor Angela Merkel said the debt swap talks were on a good path.

Senior EU, IMF and ECB officials are holding talks with the Greek government in parallel with the debt swap talks, to flesh out a new 130-billion euro bailout for Greece. They have warned they need the debt swap to cut Greece's debt substantially in order to go ahead with the new loans.

Talks with the troika inspectors on the new bailout program are expected to go well into next week.

A senior German official said Greece was not expected to play a major role at the EU leaders summit on Monday and that Germany does not expect the troika to deliver a report on Greece's progress before the summit.

Greece has made little progress on reforms as it stumbles through its worst post-World War II economic crisis. The task facing the country has been made harder with anger against austerity measures and squabbling politicians running high.

A poll on Thursday showed Greece's conservatives had widened their lead over socialist coalition partners ahead of elections expected in April, but they would not win an absolute majority if elections were held now.

Eurogroup chairman Jean-Claude Juncker was quoted in a German newspaper as saying the euro zone would probably have to support Greece longer than expected -- more than 10 years.

(Additional reporting by Sarah White and Sophie Sassard in London, Paul Taylor and Axel Threlfall in Davos, Harry Papachristou, Tatiana Fragou, Renee Maltezou and Karolina Tagaris in Athens; Writing by Deepa Babington; Editing by Dan Grebler)

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