Greece's position in the single currency is "hanging by a thread", analysts warned last night, as left-wingers who made big gains in the elections rejected the terms of the international bailout agreed by the previous government.
Alexis Tsipras, the young leader of the radical left Syriza party, said there would be no "sneaking back in again what the Greek people threw out" on Sunday. He has instead called for a moratorium on the repayment of Greece's mountainous debt and an end to the austerity measures that some blame for the country's economic collapse.
With no coalition deal in prospect after a fractured result that put seven parties in parliament, fresh elections are now likely to be held in Greece next month. Meanwhile, German politicians warned that Athens would be cut off unless it delivers on its signed commitments under the terms of its bailouts.
Antonis Samaras, the conservative New Democracy leader, accused Mr Tsipras of "doing everything he can" to prevent a coalition deal. If no coalition emerges by the end of this week, the Greek president will appoint an interim prime minister, with elections likely to be held on 10 June.
After their second place finish campaigning on a rejection of the "memorandum" deal with Greece's international creditors, Syriza are confident they can make further gains at new polls. However, any interim government is unlikely to be able to deliver the timetabled spending cuts, tax rises and labour market reforms that Athens' European partners have demanded in exchange for multi-billion euro bailouts.
Inspectors from the European Central Bank, the European Commission and the International Monetary Fund will have to rule at the end of June on whether Greece is doing enough to receive its next €11.5bn tranche of bailout funds. Unless Greece receives it, Athens would be forced to default on its entire €200bn debt pile and, analysts expect, seek an exit from the single currency.
German parliamentarians continued to warn yesterday that Greece will be cut off financially unless it delivers on its reform promises. "Aid can only flow if the conditions are met," said Gerda Hasselfeldt, of the Bavarian Christian Social Union, sister party of Chancellor Angela Merkel's Christian Democratic Union.
Nicholas Spiro, of Spiro Sovereign Strategy, said: "Right now further fiscal and structural reforms are unthinkable in Greece. Greece's membership of the eurozone is hanging by a thread."
The traded price of Greek 10-year debt shot up to 23 per cent yesterday, driven by renewed investor fears of a default by Athens. Economists at Citigroup have put the probability of a Greek exit at 75 per cent. Analysts also warned yesterday that if Greece were to crash out of the single currency, the event could potentially capsize other crisis-hit eurozone economies such as Portugal, Ireland, Spain and Italy.
"Contagion hasn't died," said Mr Spiro. "It's simply in abeyance. Greece, though it is a very small economy, does have potential to cause a lot more trouble for the eurozone."
The fear is that if investors took losses on their Greek lending, they would suddenly pull their money out of Spanish and Italian government bonds, forcing those nations to seek bailouts too. The €500bn eurozone bailout fund might be sufficient to rescue Spain, but analysts fear it would be inadequate to save Italy, which has a debt pile of €1.9 trillion. "It's almost too scary to think about," said Victoria Cadman of Investec.
Those European banks that still hold Greek bonds would register large losses if the country were to default. But European governments that have lent money to Athens since May 2010 through a joint European Union/eurozone rescue programme, including Britain, would also be hit hard.
The exposure of European governments to Greece through the two support packages received by Athens presently stands at €93bn. The European Central Bank also has €73bn exposure to Greek bonds.
Syriza and other anti-bailout parties in Greece have denounced the apocalyptic warnings as a bluff and vowed to renegotiate the deals made by previous administrations.
Money talks: How Europe is faring
The European debt crisis will be at the top of the agenda as François Hollande assumes the French presidency next week. His most urgent task will be to establish a working relationship with the German Chancellor, Angela Merkel, in a meeting in Berlin next Wednesday.
He must also try to dispel some of the confusions surrounding his proposals to kick-start growth in Europe and move way from "austerity as something inevitable". The Hollande camp points out that, in terms of domestic budgetary policy, the programme of the President-elect is almost as restrictive as that of Mr Sarkozy.
He will, however, try to persuade Ms Merkel that the "all-austerity" approach is self-defeating, and that while maintaining fiscal discipline at the domestic level, European governments should also agree a programme of rail, road and environment projects to boost growth. Mr Hollande wants these projects to be funded partly by existing EU funds and partly by "eurobonds" issued by the European Investment Bank, a proposition that Ms Merkel has so far refused to countenance.
Despite its pro-austerity agenda, Angela Merkel's government signalled a partial retreat from its rigid line yesterday, saying it was prepared to "talk growth" with France. It insisted, however, that it would not discuss the possibility of renegotiating the new European fiscal compact.
Ms Merkel faces a historic obligation to form a sustainable relationship with France. However, she has shown no sign of softening her stance on Greece.
Germany is enjoying its lowest unemployment rate in 20 years. Yet there are indications that German voters are also tiring of Berlin's tough policies. The parties in Ms Merkel's conservative liberal coalition suffered one of their worst defeats in regional elections in the state of Schleswig-Holstein last weekend with votes going to anti-austerity parties such as the Greens and Social Democrats.
Spain is already in the grip of a double-dip recession, with more than 5.6 million unemployed. The end of the property boom has also weakened Spanish banks, which now threaten the country's fragile finances.
Yesterday, rumours that local lender Bankia could be in need of a government bailout sent its shares down by up to 10 per cent at one point and forced the Ministry of Economy to issue a communiqué denying that such a rescue had already happened.
Prime Minister Mariano Rajoy has said, though, that the banking system will receive a major shake-up this Friday when the government releases details of fresh reforms aimed at restoring confidence in the sector.
There is the possibility of social unrest, as ordinary Spaniards face the pressures of austerity. A possible flashpoint comes up this weekend, with celebratory demonstrations planned to mark the first anniversary of the 15 May movement launched in response to the government's economic policies last year.
The Irish government, which is staging a referendum on the European fiscal treaty at the end of this month, is hoping that the current uncertainties on the Continent will diminish and that greater stability will help to ensure a pro-treaty result. It is already seeking clarification of Mr Hollande's position, hoping that he will ask for additions, rather than changes, to the treaty. This would be in line with Dublin's coalition government, which has committed itself to working closely with the EU in the wake of the bailout received by the Irish. Still, the austerity approach has proved painful, and although the government has a strong majority, it has slipped significantly in recent opinion polls.
Growing impatience at the EU-mandated austerity drive and a general anger aimed at the Italian political class led to apathy and protest votes during local elections on Sunday and Monday. With growing opposition at home and political upheaval in France and Greece, even the government of Mario Monti, a cabinet of unelected technocrats, appears to have sensed the change in the air. The Industry minister, Corrado Passera, seemed to acknowledge the shifting sands by telling reporters: "Europe has to give concrete signs that it believes in growth."
Q&A: Where does the eurozone go from here?
Q. Why is it all kicking off again?
A. Because the people of Europe have spoken – or some of them have, at least. And they've given austerity a thumbs down. Greece held elections on Sunday and two thirds of voters backed parties who oppose the austerity that the previous government has been imposing, under heavy pressure from the European Union. On the same day, voters in France elected the Socialist candidate Francois Hollande as their next President, a man who has promised to get Europe to focus on policies designed to promote growth.
Q. Is this the end for austerity?
A. Not so fast. The Germans, who have pushed rigorous fiscal discipline, have said they will not be renegotiating the "fiscal compact" agreed by almost all the leaders of Europe last December. This agreement compels all governments to set out measures to bring their deficits down to 3 per cent of GDP immediately. If Europe were growing that would be bearable. The problem is that the eurozone is in the midst of a recession and many have high deficits. Co-ordinated spending cuts and tax rises in that environment risks make the downturn still worse.
Q. How have markets reacted?
A. They don't know whether to laugh or cry. Despite his rich-bashing Socialist rhetoric many analysts have given Hollande a reasonably warm welcome. But the indecisive Greek elections are an unmitigated nightmare. If Athens cannot form a government, it will not be able to meet the terms of its EU/IMF bailout. And it is inconceivable that Germany would sanction further assistance to Greece without some commitment to further reforms and austerity. That is why an increasing number of analysts believe Greece could be heading for default and exit from the eurozone. That, in itself, might not be so bad, since Greece only accounts for 2.5 per cent of the single currency. But the danger is financial contagion could hit the rest of the weaker states of the eurozone, including Spain and Italy, creating a generalised financial panic.
Q. So what next?
A. Greece will be the main focus of the markets. If Athens defaults and crashes out of the eurozone the financial panic could be on the scale of that which followed the fall of Lehman Brothers. But markets will also be watching Mr Hollande closely to see what sort of accommodation he can reach with Ms Merkel on growth and deficit reduction. If they can agree a compromise, which sees a commitment to medium-term fiscal discipline along with new official loans for the struggling economies on the eurozone periphery and a relaxation of the immediate pace of deficit reduction, investors will probably breathe a sigh of relief. But if the old Franco-German ruling axis turns out to be broken, they will have a fresh reason to panic.