European leaders bowed to the inevitable and conceded that Greece is likely to default on its massive debt burden, which would be a first among the 17 countries using the euro.

They also abruptly shifted tack in the eurozone debt crisis by raising the possibility of using the eurozone's bailout fund to buy back Greek debt on the markets, meaning sizeable losses for Greece's private investors and reduced debt levels for Athens.

Following 12 hours of fraught negotiations in Brussels haunted by the risks of contagion in the eurozone spreading to Italy, now being targeted by the financial markets for the first time in the 18-month crisis, the 17 governments of the eurozone pointedly failed to rule out a sovereign debt default by Greece.

A statement said that, at the meeting, the European Central Bank "confirmed its position that a credit event or selective default should be avoided". There was no declaration of governments' support for the ECB position. Jean-Claude Juncker of Luxembourg, president of the Eurogroup, and Olli Rehn, EU commissioner for monetary affairs, both declined to offer one.

"That does not mean that the Eurogroup as such would do everything to provoke a credit event," quipped Juncker.

As recently as last week, eurozone ministers stressed the need to avoid default in Greece, indicating the rapid shifts under way in an escalating crisis.

Deep-seated divisions remained between the wealthy northern creditor governments and southern Europe, with market pressures pushing up Italian and Spanish borrowing costs and appearing to vindicate ECB warnings of the risks of contagion from Greece.

Italian borrowing costs hit 5.7%, their highest levels in more than a decade, while the yields, or borrowing rates, on Spanish government bonds reached 6% – the highest level since the creation of the euro.

Dealers reported a race to "safe havens" and gold priced in euros and sterling reached record levels of €1,110.48 and £979.89 an ounce in early trading before falling back, while the euro hit a record low against the Swiss franc – a safe-haven currency. Wall Street was also caught up in the anxiety, with US stocks falling 1% in early trading, while the FTSE 100 was also 1% lower.

Analysts said there was little hope of calm returning to the markets while eurozone governments remained gridlocked over how to respond despite weeks of negotiations aimed at encouraging Greece's private creditors to take part in a new bailout.

France has proposed rolling over Greece's privately held debt, mostly for 30 years, while Germany revived calls for a Greek debt swap, entailing "haircuts" for investors. The meeting remained split on the scale and modality of private creditor involvement in the new Greek bailout, the second in more than a year, EU officials said.

European diplomats said the meeting needed to be "cathartic", paving the way for a breakthrough to stave off a wider catastrophe in the months ahead. The major new developments were that eurozone governments accepted for the first time that a Greek default may be inevitable and that the eurozone's €440bn euro bailout fund should be reconfigured to buy back Greek debt.

"We stress our intention to make Greek debt more sustainable," said Jean-Claude Juncker, the Luxembourg prime minister who chairs the 17-country Eurogroup.

The interest Greece is paying on the bailout loans would be lowered, their maturities lengthened, and the "flexibility and scope" of the eurozone bailout fund would be "enhanced".

Sources said the proposal was to use the fund to reduce Greece's debt burden by buying back Greek debt from bond-holders at a discount. This is likely to be contested by Germany, the central player among the creditor countries, and could run into problems in Germany's parliament. The rules for the bailout fund would need to be rewritten, meaning the deal would need to go before MPs in Berlin, EU officials said.

But the scheme would also require the participation of Greece's private creditors who would suffer losses, long a German demand. There was no final agreement this morning amid murmurings of an emergency EU or eurozone summit being called before the end of the month.

The outlines of the new rescue emerging this morning pitted Germany against the European Central Bank, with elements of the deal designed to accommodate both camps. Bailout fund buybacks are supported by the ECB, while private creditor losses are a German condition.

Accepting that a Greek default was now impossible to avoid, EU governments are hoping it will be brief and "selective", not triggering a "credit event" on the financial markets that could wreak havoc on the credit default swap markets, also in the US, and unleash contagion.

Last week two of the three big ratings agencies predicted a Greek-style scenario for Portugal, downgrading its debt to junk, while predicting any private-sector involvement in the second Greek bailout being negotiated would be viewed as a default.

Those verdicts provoked rage from the EU. Viviane Reding, the EU justice commissioner, said: "Europe can't allow three private US enterprises to destroy the euro."

Either their "cartel" was smashed or "independent" European and Asian ratings agencies would be set up. "We can't have a situation where a cartel of three US enterprises decides the fates of entire national economies and their citizens," she said.