By Lefteris Papadimas and Kirsten Donovan
ATHENS/LONDON (Reuters) - Financial markets reacted skeptically on Monday to a record 110 billion euro ($146 billion) EU/IMF bailout for Greece, with investors expressing doubts whether it would solve the euro zone's debt crisis.
Despite Sunday's agreement by European finance ministers on an unprecedented three-year loan package, the euro fell as markets questioned the ability of the Greek government to push through new austerity measures pledged in exchange for aid and worried other euro states may be vulnerable.
In contrast to the euphoria that greeted past IMF rescues, Greek bond yields eased only slightly compared to benchmark German bunds, falling back to levels reached 10 days ago before last week's market panic over a possible Greek default.
The high yields will no longer affect Athens' borrowing costs since euro zone partners and the International Monetary Fund will effectively cover Greek credit needs for the next three years at lower rates of 5 percent or less.
The yield spreads of Portugal and Spain, seen as the next targets of the markets if the Greek plan fails to calm investor jitters, also narrowed modestly.
"There's a lack of conviction that this is the silver-bullet solution. The longer-term sustainability of this level of austerity has got to be open to question," said Tony Morriss, senior currency strategist with ANZ Bank in Sydney.
Euro zone leaders will launch the first bailout of a member of the 16-nation single currency area on Friday and aim to secure parliamentary backing for national contributions by then.
The German government, which took the hardest line against a bailout after the Greek crisis erupted late last year, approved a draft law on Monday on Berlin's 22 billion euro contribution to the emergency loans -- the biggest of any EU state.
Chancellor Angela Merkel said after the cabinet decision that Germany was "stabilizing the euro as a whole."
She hopes to secure the backing of both houses of parliament on Friday, but the opposition Social Democrats are demanding an EU tax on financial transactions as a condition for their support. Merkel faces a key regional election on Sunday where voters could sanction her party for backing the bailout.
To secure the aid deal, Athens committed itself to further radical savings -- mostly on public sector wages and pensions -- on top of three previous austerity plans that have already sent thousands of people into the streets in protest.
The center-left daily Ethnos said the plan would mean five years of "asphyxiation" for the Greek people and a "violent modernization" for the economy, which is forecast to contract by 4.0 percent this year and 2.6 percent in 2011.
Even if the plan is fully implemented, it will leave Greece with a substantially higher debt mountain of nearly 150 percent of national output in 2013 and a significantly smaller economy to pay it off. Deflation could further hamper debt reduction.
Yet the Greek and euro zone finance ministers, European Commission and IMF officials insisted there had been no talk of restructuring Greece's debts -- a standard IMF prescription when a country's liabilities become unsustainable.
Many investors suspect debt restructuring will come later.
"It doesn't look like the market is convinced yet, that's the story the euro is telling," a European-based currency trader said. "This is unprecedented stuff, but the danger is it puts the focus on to Spain and Portugal."
ECB TO THE RESCUE
The European Central Bank took a further step to support Greece on Monday by suspending its minimum credit rating threshold on Greek sovereign debt, meaning that Greek bonds will remain eligible as collateral in ECB lending operations.
The decision effectively neutralized a controversial move by credit rating agency Standard & Poor's last Tuesday to downgrade Greece's sovereign rating by three notches to junk grade BB. Moody's could downgrade Greece in the coming days.
Austria's finance minister said euro zone ministers had agreed to ask banks to keep their exposure to Greek borrowers at current levels for the duration of the rescue package and avoid calling in loans or cancelling credit lines.
"The important thing is that European and Austrian banks don't flee the Greek market and make the problem still worse. Some international banks are tending to do that," Josef Proell told reporters before meeting Austria's top bankers.
In addition, ministers are to ask their national banking sectors to make voluntary contributions to the bailout.
Business daily FT Deutschland said Deutsche Bank was considering offering 500 million euros on the same terms as the government, while insurers Allianz and MunichRe were willing to offer 300 million and 200 million respectively. There was no official comment.
Economists have said that if the emergency aid fails to win over skeptical investors, European countries could end up footing a bill of half a trillion euros ($650 billion) to save other fiscally weak nations.
The euro, which analysts had expected to rally in relief over the bailout, stood at $1.3230 in European afternoon trade, down from $1.3295 on Friday. The single currency has been sliding for five months due to the Greek crisis, losing nearly 12 percent since a December high above $1.50.
"FATTEST CHEQUE IN HISTORY"
Mass circulation newspaper Bild reflected popular outrage in Germany at the bailout with the headline: "Broke Greece gets the fattest cheque in history."
But German media broadly endorsed Merkel's agreement to the rescue for the sake of preserving the euro.
The conservative Frankfurter Allgemeine Zeitung, which has been fiercely critical of Greece, summed up the mood by saying: "Many German lawmakers will agree to the Greek aid package only with clenched teeth -- both for domestic reasons and in principle ... but the time for thinking about how to tackle the euro zone's first big crisis is over."
Merkel's reluctance to commit to aid has been blamed for fuelling market panic and increasing the cost of the rescue.
Crucially, the aid would be released in time for Athens to make an 8.5 billion euro debt repayment to creditors on May 19.
(Additional reporting by Kevin Plumberg in Hong Kong, George Georgiopoulos in Athens, Boris Groendahl in Vienna, and Sarah Marsh, Madeline Chambers and Paul Carrel in Berlin)
(Writing by Paul Taylor, editing by Ralph Boulton)