Spain said on Monday that foreign banks were refusing to lend to some of its banks in the latest twist to the euro zone debt crisis, but denied it was on the brink of seeking a Greek-style European financial rescue.

Treasury Secretary Carlos Ocana acknowledged officially for the first time a liquidity freeze on some Spanish banks in the interbank market and said the government was working to restore confidence through budget cuts and structural economic reforms.

It's definitely a problem, Ocana told a conference of business leaders in the northern town of Santander when asked about the reported credit squeeze. But he said Madrid was not negotiating any financial aid package.

Spain does not need additional financing from any international institution. The rumor is false and I deny it, he said.

The fourth largest economy in the euro area, Spain needs to refinance 16.2 billion euros of bonds in July. It has been able to borrow on the markets but at a rising premium, paying an average 3.317 percent to sell three-year bonds last Thursday.

Banking sources said last week the liquidity freeze was affecting savings banks and small banks but not the country's biggest financial institutions.

Finance ministers of the Group of Seven nations -- the United States, Japan, Germany, Britain, France, Italy and Canada -- were due to confer by telephone on Monday, a spokesman for euro zone chairman Jean-Claude Juncker said.

He declined to say what the talks concerned.

The German Finance Ministry and the European Commission denied a report in the Frankfurter Allgemeine Zeitung quoting German government sources as saying EU countries would hold talks on aiding Spain in Brussels this week.

Spanish banks have been under pressure since the Bank of Spain stepped in last month to take over CajaSur, a small, 146-year-old lender controlled by the Catholic Church, highlighting the precarious position of other savings banks.

The chairman of Spain's second-largest bank BBVA said the country's top task was to restore market confidence through a mixture of deficit cutting, structural reforms and recapitalizing and slimming down its financial sector.

We need a solvent and stable financial system, a substantial reduction in the installed capacity in the sector and a sufficient injection of funds, BBVA's Francisco Gonzalez told the same conference, adding that Spanish banking faced a difficult and uncertain future.

DECISIVE WEEK

The euro and European stocks rallied at the start of a decisive week for reforms in Europe aimed at preventing a repeat of Greece's debt crisis.

German Chancellor Angela Merkel and French President Nicolas Sarkozy were due to seek an accord between Europe's two biggest economies on new rules for the single currency area at postponed talks in Berlin, three days before an EU summit.

The crisis has gone by and it's clear that we are accountable to each other. We've seen it lately with the Greek crisis and we must play by the rules, and the rules have to be changed, French Economy Minister Christine Lagarde said. ... But I'm not suggesting that the crisis has gone, has disappeared, vanished, said told BBC radio.

EU finance ministers have drafted stricter rules designed to enforce the bloc's budget deficit limit of 3 percent of national output by applying earlier and tougher sanctions to countries in breach, and extending greater discipline to public debt.

On financial markets, the euro rose 1 percent to above $1.22 and European stocks were up 1 percent to a four-week high amid optimism about the global economic recovery.

In one sign that recovery may be gathering pace, industrial production in the euro zone in April surged year-on-year more than in any month in almost two decades, data showed on Monday.

Merkel and Sarkozy will also try to reconcile Franco-German differences on the notion of a European economic government to coordinate national economic policies within the 16-nation euro area and the wider 27-member EU.

France wants regular summits of euro zone leaders, backed by a dedicated secretariat, to harmonize economic, social and tax policies and rebalance the European economic between surplus and deficit countries.

A German government spokesman reiterated that Merkel wants all 27 EU states involved in economic governance to strengthen budget discipline and increase economic competitiveness.

STRUCTURAL REFORMS

In the latest of a wave of structural reforms designed to adapt strained public finances to long-term challenges and make euro zone economies more competitive, France is set to announce an overhaul of its pension system and Spain a shake-up of its labor market, both on Wednesday.

European governments are taking advantage of the sense of urgency instilled by last month's $1 trillion financial backstop for the euro zone and, critics say, of voters' distraction by the soccer World Cup, to push through unpopular measures.

Elections in the last week have added political uncertainty in three euro zone states -- the Netherlands, Slovakia and Belgium -- which face protracted coalition negotiations after voters punished incumbents and boosted protest parties.

Inspectors from the European Commission, International Monetary Fund and European Central Bank are visiting Greece, the country that triggered the euro zone sovereign debt crisis, to check progress in reducing a massive budget deficit.

European Central Bank Governing Council member Patrick Honohan, trumpeting a concerted message from the ECB, said the market response to perceived euro zone fiscal risks had been overblown.

This (nervousness) led to the situation a few weeks ago where you had effectively frozen money markets, interbank and the like, reflecting what seems to be an overblown response to perceived fiscal risks, the Irish Central Bank chief told a conference in Dublin.

(Additional reporting by Mohammed Abbas in London, Marie-Louise Gumuchian and Padraig Halpin in Dublin, Emmanuel Jarry in Paris, Andreas Rinke in Berlin, Jan Strupczewski in Bussels; writing by Paul Taylor; editing by Patrick Graham)

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