Greece's Prime Minister, George Papandreou, spooked investors on Tuesday by announcing that a referendum would be held on a rescue package that is unpopular with the Greek people because of the harsh austerity measures that must be imposed in exchange for the bailout.
Yesterday his Cabinet backed him and confirmed plans for the referendum.
The rescue deal struck by European leaders and the IMF last week would see banks taking a 50 per cent write-down on Greek loans, reducing the country's debt by up to €100 billion ($173 billion).
The Fitch ratings agency said the referendum posed a threat to financial stability in the region.
It dramatically raised the stakes for Greece and the eurozone, the agency said, and increased the risk of a forced and disorderly default.
Grant Williamson, a director at Christchurch sharebrokers Hamilton Hindin Greene, said the news of the vote stunned investors.
"It's created a fair amount of uncertainty in the markets and it could go on for some time ... no one was expecting this," he said.
"Whether another solution can be found is pretty uncertain at this stage."
The New Zealand dollar, which was trading well above US81c against the greenback on Tuesday, also fell prey to the panic - falling to US79.14c at 2pm yesterday, before gaining ground to reach US79.37c at 5pm.
"I was surprised by the ferocity of the rally in response to the package [last week] and I've been surprised by how quickly the whole thing has unravelled," said Westpac senior market strategist Imre Speizer.
He said he expected continuing volatility to push the New Zealand dollar below US79c by Monday, and US71c by Christmas.
"It's hard to see any positive fundamentals for the kiwi."
After the news of the Greek referendum, Italy and France's 10-year borrowing costs climbed to the highest levels relative to benchmark German bonds since before the euro's creation in 1999.
"If we keep seeing yields rise in this way day after day as we now wait for this referendum, then I think you really can talk about that market being in meltdown," said Steven Barrow, a London-based economist at Standard Bank.
European Union leaders will hold talks in Cannes before the start of the Group of 20 summit today, where they will tell Papandreou there is no alternative to budget cuts imposed in the bailout plan hammered out last week. The G20 leaders will convene in the French Riviera city until the end of the week.
It also emerged yesterday that Papandreou had replaced a number of top-ranking military chiefs, including the heads of the army, air force and navy, fuelling speculation that there had been fears of a coup attempt.
- Additional reporting: Bloomberg
