By Shrikesh Laxmidas
LISBON (Reuters) - Greece faced a new surge in its debt costs on Thursday after Germany said for the first time that Athens may need to restructure its debt, a move one central banker warned would be a "catastrophe".
Growing talk of restructuring by Greece, the first euro zone member to receive a bailout a year ago, points to a new stage in the debt crisis that has driven Ireland and Portugal to seek aid and forced draconian budget cuts in Spain.
German Finance Minister Wolfgang Schaeuble acknowledged officially for the first time on Wednesday that such a step may be necessary.
But it is also clear policymakers are divided on the idea and European Central Bank Executive Board member Lorenzo Bini Smaghi warned that a Greek debt restructuring would cripple its banks and economy.
"Ultimately it's up to Greece to decide the way forward, given that it will suffer the worst consequences," Bini Smaghi told Italian business daily Il Sole 24 Ore. "But other countries must avoid pushing it towards a catastrophe."
The return investors demand to hold 2-year Greek bonds spiked to 18.30 percent, up 0.83 percentage points and the highest since after it asked for a bailout last year.
The fact that those yields are now much higher than 10-year rates, points to concern among investors that it is shorter-term bonds that will lose the most value in any restructuring.
The growing debate about the sustainability of Greece's debt load goes to the core of the troubles facing Europe's most-indebted economies as they struggle with budget cuts which undermines their ability to grow and service their debt.
Greece received a 110 billion euro bailout from the European Union and IMF nearly a year ago, followed by Ireland in November. Portugal asked for a bailout last week, which could reach 80 billion euros.
The euro also fell and Greek 5-year credit default swaps hit a record high of 1,070 basis points, up 23 basis points. Spanish and Portuguese credit default swaps rose, while Portugal's 10-year bond yields hit euro era highs of 9.16 percent.
"The severe economic recession and the lack of improvement in tax revenues suggest Greece may already be in the vicious spiral of too tight fiscal policy and too weak economic performance, where a write-off of part of the debt would be the only possible way out," said Giada Giani, an economist at Citibank, in a report.
European officials are hoping that the bailout for Portugal will be the last one, and debt markets have broadly shown both Spain and Italy appear to be succeeding in keeping investors' faith.
Italy sold five-year bonds on Thursday at yields of 3.83 percent, down from 3.90 percent last month.
But it is Spain that is first in the firing line and its 10-year bond premium in the secondary market widened 14 basis points to 194 bps.
Madrid is hoping for support from China for its efforts to recapitalise a struggling banking sector and there were also brighter signs in data showing its banks borrowed less in March from the European Central Bank than at any point in the past three years.
The Bank of Spain is set to pass judgement on savings banks' plans to raise capital later, giving investors a clearer picture of how the regional banks plan to plug their funding gaps.
In Lisbon, union leaders were preparing their response to what they expect to be harsher austerity as Brussels and IMF officials put together new measures in return for a loan.
Recession-weary Portuguese have already staged several large protests and a series of transport sector strikes against austerity in the past few weeks.
European Commission and IMF officials started poring over Portugal's public accounts this week and Finance Minister Fernando Teixeira dos Santos said on Tuesday that he hoped a bailout would be finalised and approved in mid-May.
The nervousness over Portugal's situation could rise ahead of the weekend as Finland goes to the polls in a parliamentary election that could lead to eurosceptic parties opposed to a bailout for Lisbon getting into power.
In Ireland, data released Thursday showed consumer prices jumped at their fastest annual pace in nearly two and a half years, adding pressure on consumers who are already suffering from falling wages, higher jobless and cutbacks.
Still, the Irish central bank said on Thursday gross domestic product should grow 0.9 percent this year, only slightly down from a previous forecast of 1.0 percent.
(Additional reporting by Noah Barkin in Berlin and Carmel Crimmins in Dublin)
(Writing by Axel Bugge; editing by Patrick Graham)