By Jeremy Gaunt, European Investment Correspondent
LONDON, June 27 (Reuters) - Investors went on the defensive on Monday ahead of a Greek austerity vote that may sow stronger doubts about financial stability and economic recovery.
Wall Street looked set to rise at the open and European shares managed some cautious gains. But stock market volatility in Europe hit a 14-week high.
Earlier jitters were eased slightly by comments suggesting France was making progress on how to involve bondholders in a Greek rescue deal.
Greek lawmakers will begin debating a 28 billion euro ($40 billion) package of measures to increase taxes and cut fiscal spending that is critical to winning a new round of international funding to keep it afloat.
A rejection of the austerity plan could greatly worsen pressures already reflected by rising Portuguese and Spanish government bond yields, possibly bringing high-risk Europe closer to a chain of sovereign defaults that would blow out interbank funding costs and place heavy stress on the region's banking system.
The risk of a credit event of this magnitude is keeping two-year U.S. interest rate swap spreads near the widest in a year and helping to lift the U.S. dollar out of a downtrend that has lasted a year.
"If the government wins, there would be some bounce in shares. But it does not change the long-term story. Greece's finances are pretty unsustainable and until it starts dealing with its ability to raise funding internally by more efficient tax collection, investors will continue to be nervous," said Felicity Smith, fund manager at Bedlam Asset Management.
"Investors are more concerned about its effect on the banking system. If there is a disorderly default, then there is a real risk of another Lehman-style shock and its knock-on effects on other peripheral euro zone countries," she said.
EURO WEAK
The euro recovered early losses after struggling near a record low against the Swiss franc and was slightly stronger against dollar.
"Most investors expect Greece's vote to get through, but they still want to lighten their positions in the euro to remove risk as there is a great deal of uncertainty," said Daisuke Karakama, market economist at Mizuho Corporate Bank.
The euro, which plumbed a record low against the Swiss franc around 1.1800 on Friday, was last around 1.1853 francs.
Against the dollar, the euro was up 0.2 percent at $1.4214 after dropping as far as $1.4102 -- its lowest since June 16.
Yields on core euro zone government bonds were slightly higher. (Additional reporting by Atul Prakash and Kevin Plumberg; Written by Jeremy Gaunt; Editing by Hugh Lawson)