(Reuters) - Spain has at last conceded it may need a state bailout and policymakers are considering writing down Greek debt to their central banks, European officials said on Friday, as markets anticipated radical new action to pull the continent out of its debt maelstrom.

European Central Bank President Mario Draghi, who on Thursday pledged to do whatever was necessary to protect the euro zone from collapse, is also set to meet Germany's Bundesbank President Jens Weidmann to discuss a raft of other measures to address the region's crisis, according to a Bloomberg report.

Citing two central bank officials, the report said Draghi's proposal involves Europe's rescue funds buying government bonds on the primary market, flanked by ECB purchases on the secondary market to ensure transmission of its record low interest rates.

Weidmann poses the biggest obstacle to any ECB plan to buy government bonds, and Draghi would need to win him over. A Bundesbank spokesman said meetings between the two men "are not unusual; they take place if there is something that needs to be discussed".

An ECB spokeswoman also said it was usual practice for Draghi to meet with governing council members such as Weidmann, but declined further comment.

The Bloomberg report also said Draghi favoured granting a banking licence to the euro zone's planned permanent bailout fund, the European Stability Mechanism (ESM), which would allow it to borrow money and deploy more firepower if called upon to rescue an economy as big as Spain's.

The crisis in the euro zone has been thrown into higher gear by a surge in borrowing costs for Spain and by an acknowledgement by Brussels officials that Greece is too far off its targets to be saved by its second bailout package, agreed just five months ago.

Spain, the next country in the firing line, is far larger than the four other countries that have accepted EU bailouts, and rescuing it would require action on a scale as yet unforeseen. It may be a price that needs paying to save the single currency, analysts say.

Though far smaller, Greece has the potential to send shockwaves across the region should it default on its debts and leave the euro. The European officials on Friday described a further restructuring of Greek debt as a last chance to restore the country to solvency.

A euro zone official said Economy Minister Luis de Guindos had brought up the prospect of a 300 billion euro bailout this week at a meeting with Germany's Finance Minister Wolfgang Schaeuble.

"De Guindos was talking about 300 billion euros for a full programme, but Germany was not comfortable with the idea of a bailout now," said the official, who spoke on condition of anonymity.

He said the question would be put off until the ESM is up and running. He also said Germany appeared to be softening its opposition to giving the ESM a banking licence.

SPANISH EMERGENCY

Madrid has already accepted a lifeline for its banks while insisting publicly that it does not need a rescue for its state finances. But with its borrowing costs breaching levels that forced Greece, Portugal, Ireland and Cyprus to seek bailouts, it could have little choice but to seek emergency financing.

Asked about the European source's comments, a Spanish government spokeswoman said: "We strongly deny any such plan. This possibility (of a 300-billion-euro rescue for Spain) has not been looked at and has not been discussed."

News that policy makers were considering having central banks write off some of their Greek debt was another sign of radical measures contemplated behind the scenes.

Private sector holders of Greek debt already wrote off most of the value of their holdings this year in history's biggest sovereign debt restructuring, agreed alongside a 130 billion euro second package of EU, IMF and ECB loans to rescue Athens.

But officials said there was now a recognition that Greece remains too far off its reform targets to pull itself out of the crisis while its economy, in its fifth year of recession, shrinks ever faster, eroding its ability to pay its debts.

That increases the likelihood of official lenders writing down their loans, known as "official sector involvement" or OSI.

"If I were to assign a percentage chance to OSI in Greece happening, I would say 70 percent," one euro zone official involved in the deliberations told Reuters.

One option being worked on would involve the ECB and the national central banks that make up the Eurosystem - the single currency's architecture - writing down the value of the Greek government bonds they hold by 30 percent.

Total outstanding official debt to Greece is about 220-230 billion euros. One official said the proposals would reduce that by about 70 billion. Another put the figure at 70 billion-100 billion.

INTERVENTION

Markets remained focused on Friday on the prospect of intervention by the ECB.

French newspaper Le Monde reported that the ECB and euro zone governments were preparing co-ordinated action to cut Spanish and Italian borrowing costs. European shares extended gains to trade about 1 percent higher after the report's release.

The euro zone's two most powerful politicians, German Chancellor Angela Merkel and French President Francois Hollande, spoke on the phone and issued a joint statement. Echoing Draghi's pledge on Thursday, they said they were "determined to do everything to protect the euro zone".

But Germany's Bundesbank pushed back, saying purchases of bonds by the ECB to reduce borrowing costs of governments would be "problematic". Germany regards such measures as potentially allowing the ECB to finance state spending, which it views as against European law.

Le Monde, citing unnamed sources, said the ECB was willing to take part in action to lower the bond yields of countries such as Spain and Italy if governments agreed to tap the bloc's bailout funds, the existing European Financial Stability Facility (EFSF) and the ESM, which will replace it.

The Bundesbank regards central bank purchases of sovereign debt as monetary financing of governments, which the ECB is barred from doing by European law. The German national central bank's resistance could narrow the ECB's options.

"The mechanism of bond purchases is problematic because it sets the wrong incentives," a Bundesbank spokesman told Reuters.

The Bundesbank saw the possibility of the EFSF bailout buying government bonds "as less problematic", he added.

Schaeuble said he welcomed Draghi's determination to defend the euro zone and Berlin said it stood ready, just like the ECB, to do all in its power to ensure the survival of the euro.

In Paris, French Finance Minister Pierre Moscovici said: "I trust Mr. Draghi to do exactly what is needed, that is to act so that markets are appeased and there can be a relaxation of the interest rates for Spain, for Italy."

ECB policymaker Ewald Nowotny broke ranks with his colleagues on Wednesday by saying he saw merit in giving the ESM a banking licence so it could tap ECB funds.

The Bundesbank said that would be against EU rules.

But the euro zone official who revealed the new talk of a bailout for Spain said Nowotny's remarks were a "test balloon".

"I feel that the Germans are changing their position on this. They are scared, and with good reason, and their opposition is softening."

(Additional reporting by Eva Kuehn in Frankfort, John O'Donnell and Luke Baker in Brussels, Nicholas Vinocur in Paris, Gareth Jones in Berlin and Sakari Suoninen in Frankfurt; Writing by Peter Graff/Will Waterman; Editing by Andrew Heavens)

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http://www.reuters.com/article/2012/07/27/us-eurozone-spain-idUSBRE86Q0JS20120727