Investors lost their nerve today after Greece became the first state since Zambia to delay a scheduled repayment to the International Monetary Fund, leading to fears spread of a snap election in the country.
The FTSEurofirst300 shed 0.6% putting the pan-European shares index on course for its biggest weekly fall since December.
"By postponing today's payment, Greece de facto acknowledges that it is running out of money fast," said Holger Schmieding of Berenberg Bank.
"I would stay short until there is more clarity on Greece," said Mike Reuter, a senior equities sales trader at Tradition.
Some analysts pointed to the rising risk of a political explosion in Greece as creditors seek to force Alexis Tsipras’s radical Syriza government to break some of its manifesto commitments in exchange for €7.2bn in bailout funds.
"We think a compromise on policies by the Greek government could trigger a political crisis that could accelerate deposit outflow and result in the imposition of administrative controls on Greek banks," said analysts at Barclays.
Deposits have been flowing out of Greece banks as domestic savers fear the imminent imposition of capital controls. That has forced the country’s lenders to rely on ever more emergency liquidity funding from the European Central Bank.
Yesterday the IMF revealed that Greece has asked late in the day to exercise an obscure clause which allows debtors to bundle repayments due to the Fund over a month to the end of the month, despite previous assurances from senior Greek ministers that today’s €300m payment would be made.
The last government to exercise this right was Zambia in the 1980s. Greece must now pay €1.6bn on 30 June or be in technical default – something that could see its banks unable to borrow any longer from the ECB. There are growing signs that Athens will be unable to make the payments unless it receives the bailout funds from its creditors.
Tsipras was presented with a “take-it-or-leave-it” list of reforms by the European Commission, the European Central Bank and the IMF in Brussels on Wednesday. He will address a restive Greek parliament, where Syriza holds a majority, this afternoon with reports suggesting he is set to call on the country’s creditors to "get realistic" and ease demands that Greece dismantle labour market protections, cut public pensions and run a substantial primary budget surplus.
There are growing signs of serious splits within Syriza, which could prevent Tsipras reaching an agreement with creditors even if he wished to.
The deputy social security minister Dimitris Stratoulis, who is associated with the party’s left wing, said today: "The lenders want to impose hard measures. If they do not back down from this package of blackmail the government... will have to seek alternative solutions, elections".
The German Chancellor, Angela Merkel, admitted last night that "we’re still far from reaching a conclusion".Reuse content