Yields on 10-year Greek bonds jumped 31 basis points to 9.57pc and the euro tumbled 2 cents to $1.385 against the dollar as investors awoke to the risk of political upheaval in Greece, not helped by warnings from bond giant PIMCO that Athens will default within three years.
"We have not yet escaped the danger. I am sounding the alarm," said Mr Papandreou.
While he promised to stick to the EU-IMF austerity plan, he threatened to go to the country if upcoming local elections fail to give his socialist PASOK party a clear mandate. "There can no deadlock in democracy, the people have the power to decide," he said.
The main opposition group New Democracy has yet to give a watertight pledge that it would abide by the terms of the EU's €110bn (£97bn) rescue, or the "Memorandum" as it is known.
PASOK itself is fraying at the edges in any case. A socialist rebel candidate from the "anti-Memorandum" bloc leads the polls for the Athens region.
Mr Papandreou is responding with populist gestures, granting pensioners a €300 bonus and rejecting calls by Brussels and his own central bank for further belt-tightening. "There will be no new measures on wage-earners or pensioners, they have paid enough," he said.
The fiscal picture is extremely delicate. Eurostat is expected to raise Greece's budget deficit for 2009 to 15.1pc of GDP from 13.3pc. Public debt will rise to 127pc instead of 115pc, bringing the country closer to a debt compound spiral.
Mohamed El-Erian, chief executive of Pimco, said the EU-IMF package prevents Greece from growing its way out of the crisis and will test political consensus to destruction. He said it would be healthier for both Greece and Europe to opt for orderly debt restructuring.
Most investors seem to agree that the EU-IMF plan is unworkable, merely buying time for German and French banks to shift Greek liabilities on to EU taxpayers. A Barclays survey found that 82pc of clients expect the eurozone to face a debt restructuring, a sovereign default or even a full break-up by 2013.
Hans Redeker, currency chief at BNP Paribas, said global attention may switch back to Europe once the US Federal Reserve clears the air on quantitative easing next week.
"We are seeing a complete failure of the EU to agree on common foundations for how to solve the eurozone's problems. Germany is demanding a mechanism for controlled bankruptcy but the high-debt states refuse to accept this," he said.
"And over the next few months we are going to find out what fiscal consolidation in Europe really means."
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