Ed Balls said a failure to reach agreement in Brussels could have catastrophic consequences for the UK

Deeper fiscal co-ordination among eurozone members is the only way to avert a "calamitous debt crisis", Ed Balls said on Wednesday as he accused chancellor George Osborne of a "failure of leadership" before a crunch Brussels summit.

Balls, Labour's shadow treasury spokesman, warned that the UK government's hands-off stance on Europe meant one of the top three economies in the EU was in effect abdicating responsibility for resolving a crisis that could engulf the British economy.

He backed the creation of eurobonds to fund a bailout package that would also involve eurozone countries agreeing greater co-ordination and guarantees to protect member states' debt mountains.

He urged the prime minister, David Cameron, and Osborne to join leaders in Brussels to hammer out a deal. "There isn't any possibility of getting through this crisis without at least a temporary eurozone-wide guarantee based on government-issued debt from countries at risk from contagion. Without that support the markets are going to continue to lose confidence. We need to face up to today's problems. When you see Italian and Spanish bond spreads you can see the situation is incredibly dangerous," he said.

He said a failure to reach agreement in Brussels on Thursday could have catastrophic consequences for the UK and it was bizarre the chancellor would be playing virtually no role in supporting efforts at reaching a deal: "At a time when leadership is needed, the UK government should be in Brussels leading the way. I think people will look back at the last few weeks and ask why, when we faced a potential American [debt] crisis and a developing European crisis together with deepening problems in the UK around growth, what happened to UK leadership in this period? Where was the prime minister and chancellor, why weren't they setting the agenda?" he said. "We have a direct interest in getting this call right."

Balls said the News International phone hacking saga had distracted Tory senior politicians who were not giving their full attention to the debt crisis as a result of the need to "firefight to save their reputations".

EU leaders are under pressure to agree new funding arrangements to prevent Italy and Spain from needing a bailout on similar terms to Ireland, Portugal and Greece. Failure to reach an agreement could trigger a run on Italian and Spanish bonds, with yields reaching levels where it is unaffordable to borrow.

Several economists have warned the EU faces its "Lehman's moment" if leaders fail to agree a strategy and Greece is forced to default on its loans. UK and continental banks face losing billions of pounds as investor flee the EU.

Proposals for an expansion of the European Financial Stability Facility (EFSF) into a €1.5tn (£1.3tn) fund have gained support among EU countries, but have yet to win favour in Berlin.

The German chancellor, Angela Merkel, remains opposed to plans that would reduce some of Athens' debt mountain as part of the deal, without private sector investors taking a similar loss.

Balls said it was misguided for ministers to believe the UK could avoid being affected by an escalation of the eurozone crisis and argued the UK was more exposed to the eurozone's financial problems after a year of low growth brought on by cuts in public spending and the rise in VAT to 20%.

"The British government should not be saying it is a eurozone problem or that we are not in the eurozone so we have no locus. They should be demanding to attend meetings we are not invited to, because this affects the British interest, and saying as a senior European nation that we can act as an honest broker. We should be charting the way." He disagreed with critics who argue Britain is prevented from taking a bigger role after its refusal to join the euro or provide further bailout funds.

A spokesman for George Osborne said that while the chancellor will be in the UK, he is engaged in the debate through the finance ministers' group Ecofin, the G7 and extensive bilateral talks with other eurozone leaders.

"This is desperate stuff from Balls. George speaks to European finance ministers constantly," he said.