By Michael Shields and Philip Blenkinsop
VIENNA/BRUSSELS (Reuters) - Pressure on Germany and France to take radical action on the euro zone debt crisis mounted on Friday, as financial markets sagged further and Belgium added its support to calls for the region to issue debt jointly.
Belgian Finance Minister Didier Reynders said the bloc should issue common euro bonds and expand its bailout fund to calm repeated market selloffs of government bonds and bank shares of vulnerable debtor countries.
Germany has led resistance to both proposals. Belgium's support for bonds promoted by high-debt nations such as Italy and backed by some European Commission officials will not necessarily tip the balance.
But Reynders' call in the Financial Times for the euro zone had to prove it had "deep pockets" underlined increasing fears among euro zone governments that they would be unable to reassure investors that euro zone banks are safe without drastic action by the 17-nation bloc.
Merkel repeated her criticism of proposals for euro zone bonds, telling a rally of her Christian Democrats this was a "slippery slope" that would probably leave everyone worse off.
"Euro bonds would not allow any rights at all to intervene to force discipline on others," she said.
French Prime Minister backed her view, writing in an editorial published in daily Le Figaro that common euro zone bonds without further fiscal consolidation could threaten France's triple-A credit rating.
Bickering over the latest Greek bailout and lingering disappointment over Wednesday's Franco-German summit helped drag European shares to near two-year lows on Friday.
Fears that major world economies are heading for recession are adding to worries that euro zone banks face short-term funding troubles, losses from sovereign debt and weak trading income.
Greece, at the center of the euro zone debt storm, also announced its economy would shrink by more than previously thought -- by 4.5 percent this year against an earlier estimate of 3.8 to 3.9 percent.
"The best way to resolve a debt crisis is to grow out of it so a recession certainly would not help. I think the confidence element is very important now," said ING economist Martin van Vliet. "It's time to break the downward spiral of a self-fulfilling recession. We are in that stage right now."
Spain's announcement of further austerity measures and a move to support its stricken housing market, aimed at showing it was working hard to stay out of the debt crisis, had little market impact.
Market impatience with the pace and complications of euro decision-making has been heightened by a rush by smaller euro economies to demand collateral from Greece in return for contributing to its bailout fund, and Austria sought on Friday to resolve that dispute.
The collateral demand, first made by Finland, has ruptured the common line found at the July 21 summit, particularly after Austria, the Netherlands and Slovakia said on Thursday they deserved the same treatment.
Dutch finance minister Jan Kees de Jager described as "very complicated" Austria's proposal that more collateral should be available to countries whose banks and insurers were less exposed to Greece.
Marco Valli, chief eurozone economist at UniCredit, said that Europe needed more than ever to be speaking with one voice.
"If you want to sell your pact to save Greece then you should not be fighting about this. It undermines the credibility of the package," he said.
For markets though, the issue of collateral may be more of a sideshow compared with the debate on additional support for the zone.
Germany, the euro zone's chief paymaster, has repeatedly opposed a big increase in the bailout fund and says that common euro zone bonds would remove incentives for fiscal prudence, rewarding profligate nations.
European Central Bank heavyweight Juergen Stark described jointly issued bonds on Friday as a "false solution."
Even so, BNP Paribas Chief Eurozone Market Economist Ken Wattret said he believed euro zone leaders would ultimately agree to launch common bonds and to increase the bailout fund.
"It would be helpful for markets if the EFSF were increased now, but the political reality is that this is unlikely to happen until at least later in the year," he said.
(Additional reporting by Sara Webb in Amsterdam, Stephen Mangan in London, Petra Wischgoll in Hameln, Germany, Marc Angrand, Nicholas Vinocur in Paris)