European policymakers scrambled on Friday to reassure markets on the stability of their 16-nation currency bloc as investors shed euro assets for a second day on fears about debt-laden member states like Greece and Portugal.

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

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 levels under control.

Markets also focused on Portugal, where parliament was due to vote on a regional financing bill that is seen as a crucial test of the government's ability to curb spending.

Alongside Greece and Spain, Portugal is one of a handful of euro bloc countries that face intense pressure to get their public finances in order and calm markets worried about the risks of a sovereign default.

Analysts are no longer discounting the possibility that a smaller member of the bloc 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 Nowotny. If the faith is lost, rates will go up significantly.

Reflecting the scope of the concerns, investors in the United States and Asia shed risky assets overnight and moved into U.S. Treasuries and Japanese yen, both seen as safe havens.

CONFIDENCE BRITTLE

The euro tumbled below $1.37 and slumped against other safe-haven currencies like the Swiss franc, forcing the Swiss National Bank (SNB) to take the unusual step of intervening in the market.

Greek stocks <.ATG> were down 4 percent by early afternoon, while Portuguese <.PSI20> and Spanish <.IBEX> shares shed over 3 and 2 percent, respectively, after tumbling 5 to 6 percent on Thursday.

The cost of insuring Greek, Portuguese and Spanish government debt against default shot up to record highs and the premiums investors demand to buy euro zone government bonds other than liquid German benchmarks rose broadly in a sign of growing unease about fiscal divergences in the bloc.

There is now significant downside pressure on global indexes, with fear spreading that the situation in Greece could creep into other weaker European economies, said Owen Ireland, an analyst at ODL Securities. Confidence is extremely brittle.

The Portuguese government is hoping parliament will reject the opposition-led regional financing bill on Friday because it fears it would hamper its ability to cut a budget deficit projected to total 8.3 percent of gross domestic product (GDP) this year.

But a parliamentary committee backed the bill on Thursday, raising the specter of a defeat for Prime Minister Jose Socrates that could spook markets further.

THREAT OF UNREST

Like Portugal, Greece is struggling to convince investors that its austerity program is credible.

I can understand the doubts but that's why we have to prove (ourselves). We will credibly apply this program, Prime Minister Papandreou said in New Delhi.

Greece has pledged to reduce its budget deficit to 8.7 percent of GDP this year, down from 12.7 percent in 2009 -- a target the European Commission has described as ambitious but feasible.

Markets are skeptical, however, particularly given the mounting threat of social unrest in a country with a history of violent protest. Greek tax officials kicked off a series of strikes against the government's austerity plan on Thursday and a wider public sector strike is scheduled for February 10.

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

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

The government was due to detail a series of labor reforms on Friday. Unemployment in Spain, whose economy has slumped since the bursting of a construction bubble, is nearing 20 percent and the Bank of Spain said on Friday that GDP fell 3.6 percent in 2009, the steepest drop in decades.

(Reporting by Andrei Khalip in Portugal, Brian Love in Paris, Terhi Kinnunen in Helsinki; Abhijit Neogy and Manoj Kumar in New Delhi; Writing by Noah Barkin)

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