Financial markets were plunged into fresh turmoil after Greece's political parties failed once again to agree to form a unity government, and European policymakers warned that Greece's aid payments would be cut off unless Athens quickly produced an administration prepared to deliver far-reaching economic reforms and budget cuts.
Without those funds from the European Union and the International Monetary Fund, Greece could run out of cash to meet its national debt interest payments as early as next month. The country would then have no option but to default. Most analysts expect that a default would be a prelude to Greek exit from the single currency altogether.
Stock markets across the world saw heavy selling in response to the threat of a break-up of the 17-nation eurozone, with the FTSE 100 index in London falling by 1.97 per cent. Germany's DAX slid by 1.94 per cent and France's CAC took a 2.29 per cent hit. Wall Street slumped by 1 per cent upon opening. Confidence in the international bond markets also plummeted, with Spanish and Italian sovereign borrowing costs shooting up back to unsustainable long-term levels. Madrid's 10-year sovereign bond yields rose to 6.24 per cent, as investor concerns mounted that Spain, which is struggling to prop up its ailing banking sector, could be the next eurozone state to require a bailout.
The leaders of Greece's major political parties have until Thursday, when parliament is due to convene in Athens, to form a national government. Otherwise new elections will be called for June. Opinion polls suggest that those polls would simply strengthen the hand of parties opposed to the terms of the EU/IMF bailouts.
The moderate Democratic Left party said yesterday that it would not join a coalition without the involvement of the far-left Syriza party, which won the second largest share of votes in the 6 May election and which has refused to accept the conditions attached to Greece's two multibillion-euro rescues.
A spokeswoman for the European Commission said Greece's future remained in its own hands, but added that there could be no question of renegotiating the conditions attached to Athens' international support package. "We wish Greece will remain in the euro and we hope Greece will remain in the euro ... but it must respect its commitments," said Pia Ahrenkilde Hansen.
There were reports from some trading desks in the City that some institutions had already asked about how to include the drachma on their systems.
The German government of Angela Merkel has been the driving force behind demands that Greece commit to deep austerity in return for external support. "It is undisputed that the Greek people have to suffer from the consequences of decades of neglect," said the German Finance Minister, Wolfgang Schauble, arriving in Brussels yesterday for a meeting of economy ministers. "There is no easy path for Greece whatever the result."
Greece is also being kept afloat by the European Central Bank, which has allowed the country's private banks to refinance themselves by swapping Greek sovereign bonds for euros. Yet in recent days European monetary officials have begun to discuss the prospect of life without Greece. "I guess an amicable divorce if that was ever needed, would be possible," said Luc Coene, Governor of the Belgian central bank. Patrick Honohan, the head of the Irish central bank, said that a Greek exit "can be managed". The Dutch Finance Minister, Jan Kees de Jager, also suggested in Brussels that the eurozone could cope with the potential contagion of a Greek exit.
But some analysts warned that eurozone policymakers were being dangerously complacent. "Whoever tells you a Greek exit would be no big deal is an idiot, lying or disingenuous," said Sony Kapoor of the European think-tank Re-Define. Economists fear that a disorderly exit would prompt a huge run by investors on Spanish and Italian debt, forcing those countries to seek support from an EU bailout fund, which, with a capacity of just €500bn, is widely regarded as too small to cope with those pressures.
Official figures show that the collective factory output of the single currency area shrank by 0.3 per cent in March. And data released today is expected to confirm that the currency bloc is officially back in recession, with a contraction of 0.2 per cent in the first quarter of 2012, following a 0.3 per cent shrinkage in the final three months of 2011.
Where now? Greece's rocky road ahead
Today Redemption of €440m bond and short-term-debt auction
Thursday 17 May Deadline for parties to form unity government, otherwise fresh elections triggered for some time in June
Friday 18 May €3.5bn bond redemption and rollover of €1.6bn in short-term borrowing
10 June Possible election date
15 June Rollover of €2bn in short-term borrowing and €600m interest on bilateral EU and IMF loans
17 June Possible election date
22 June Rollover of €2bn of short-term borrowing
End of June Troika (EU, IMF, ECB) to rule on whether to release Greece's latest bailout payments
20 August €3.2bn bond redemption due – impossible without bailout