The German Chancellor, Angela Merkel, received support for her refusal to bail out weaker euro members from an unexpected quarter last week: the markets.
Investors worried that Berlin might compromise its reputation for prudence by underwriting a pan-eurozone bond marked down the value of the country's debt severely.
A country that has been seen as a safe haven, while peripheral nations struggled, suddenly lost its attraction. And the prospect of those countries' problems impacting on Germany means that economists believe Mrs Merkel will now find her economy back in recession.
With Italian bond yields back above 7 per cent – despite the change of government – and Portuguese yields exceeding 13 per cent after its bonds were downgraded to junk status, those governments are keen to create eurozone-wide bonds that would be backed by Europe's biggest and strongest economy.
So keen have investors been for Germany's AAA-rated bonds that they have eagerly switched into them, even though they paid less than 2 per cent. But advocates of the eurozone bonds failed to realise that pooling the peripheral nations' debt with Berlin's would pull up German yields.
The lesson came at the regular auction last week, when Mrs Merkel's government offered new debt to replace maturing bonds. Bids were received for only two-thirds of the issue. Rather than buy German bonds, investors became sellers.
Yields jumped to 2.23 per cent as money switched into countries that will not have to bail out Spain, Greece and the other troubled nations. Demand for UK government debt has become so strong that UK bond yields are now lower than Germany's.
However, trouble in Europe, especially the likelihood of a return to recession, affects British companies, many of which have subsidiaries on the Continent and whose main export market is the eurozone.
Economists believe Germany's economy may shrink by 0.4 per cent during the current quarter, reversing growth during the rest of the year. Ian Richards, an equity analyst at Royal Bank of Scotland, says: "Europe faces bleak growth prospects as the co-ordinated austerity measures bite. We see the euro-area economy flirting with recession throughout 2012."
Only a late recovery on the London stockmarket on Friday afternoon ended a nine-day run of consecutive falls, matching the FTSE 100 index's worst performance ever. Even so, the index has fallen 7 per cent in the past fortnight.
Eurozone finance ministers will meet on Tuesday to discuss the problems of the single-currency area ahead of a meeting of all EU finance chiefs the following day that will include British Chancellor, George Osborne. The summits will be dominated by the change in Germany's position.
Last week's events in the bond markets should harden Mrs Merkel's resistance to using her country's hard-earned strength to bail out heavily indebted countries that are slow to reduce their budget deficits. She will be backed by Holland, Austria and Finland, also with AAA credit ratings.
Trevor Greetham, a fund manager at Fidelity, says: "After Germany's troubled bond auction, the 10-year yield has risen above that of the UK ... However, some are saying that the rise in yields is evidence of German credit deterioration due to the liabilities they will inevitably pick up from peripheral countries."
The Frankfurter Allgemeine's headline after the auction declared: "The credit crisis reaches Germany." Some hope such worries will bounce Mrs Merkel into agreeing to back eurozone bonds or allowing the European Central Bank to intervene further in markets. But Mr Greetham says: "The rise in yields could harden German attitudes against the proposals for euro bonds that the EU is currently exploring."
While the UK is not a member of the single currency, a British MEP is chairing the EU's key economic and monetary affairs committee that is considering the bonds. Sharon Bowles, a Lib Dem, is a supporter of these euro bonds, but admits they are not a short-term solution.
She blames Berlin and the central bank for putting the maximum pressure on countries to reform – "up to the moment where they go bust". She claims: "This approach has broken the eurozone sovereign debt market. Unorthodox options such as euro bonds should be considered." However, other members of her committee have criticised "Brussels diktats" for imposing unpopular measures.
Mrs Merkel is demanding a fiscal union that will allow the stronger nations to impose financial constraints on countries seeking help. These will be discussed at an EU summit in Brussels in early December but that will require changes in the union's treaties and Britain is likely to veto any move to centralise controls. That will delay any launch of euro bonds.
Jacques Cailloux, the chief European economist at RBS, says: "Resistance by the ECB, Germany and some other euro-area countries reflects fundamental differences in schools of thoughts around the consequences of debt monetisation which might take more time than people think to be appeased, making a full-scale intervention by the ECB unlikely in our view."
Ms Bowles last week met Olli Rehn, the European economic commissioner, who told her that consultation on issuing such bonds will be completed by 8 January. She fears the timetable will be too slow to solve the current problems, however. "The European Commission has done well to come forward with options for euro bonds as a measure for helping eurozone countries pool their debts in the future," she says. "These options are plausible two years down the line, but what about now?"
She is proposing one-year "euro bills" as an interim measure, with each country paying different interest rates that reflect their economic strength. "There would also be an incentive for the countries to stay on track," she adds. "If they did not keep on track they would not get to reissue the euro bills next year."
But the short-term worry for Mrs Merkel and for the other eurozone leaders is the prospect that Germany has already returned to recession. A country that relies heavily on exports of manufactured goods is finding markets drying up in the countries that are having to impose severe austerity programmes. Gross domestic product grew by a healthy 2.9 per cent over the past year but is forecast to have contracted by around 0.4 per cent during the fourth quarter of 2011, despite surveys claiming German consumer confidence remains high.
So not only is the credit crunch affecting the price the German government pays to borrow, it is influencing output in its manufacturing base. That will have an impact on employment and profits and will reduce the tax income received by the state, thus increasing the country's currently small budget deficit and requiring it to borrow even more.
That fear of recession across Europe has destabilised stockmarkets. While the late upturn in prices on Friday afternoon avoided the FTSE 100 rewriting the record books, investors remain nervous.Reuse content