Pressure on Greece increased dramatically on Wednesday night after Germany's central bank called for a suspension of financial support to Athens and eurozone finance ministries agreed to draft contingency plans for a Greek exit from the euro.
In a blunt warning to Athens, the Bundesbank said a Greek withdrawal from the eurozone would be disruptive but "manageable", undermining claims by Greece's radical anti-austerity leader, Alexis Tsipras, that Europe would not dare pull the plug.
"When the Eurosystem provided Greece with large amounts of liquidity, it trusted that the programmes would be implemented and thereby ultimately assumed considerable risks," said the bank. "In the light of the current situation, it should not significantly increase these risks."
The German financial daily Handelsblatt said the Bundesbank was "holding a gun to Greece's head", hammering home the message that Germany will not submit to blackmail from populist politicians in Athens.
Berlin also leaked news that their member on the European Central Bank board, Jürg Asmussen, is to head an ECB taskforce to handle the Greek crisis.
There was confusion in Brussels over leaks that EMU finance ministry officials had agreed in a meeting on Monday allegedly in the name of Eurogroup executives that each state should draw up a national plan to cope with a Greek exit.
Athens issued an angry denial, saying the claims were false. The European Commission stressed that it was not told about the meeting, even though it is a member of the working group. "We are not preparing such a plan, though we are ready to face any eventuality," said an official.
There were suspicions that Germany had leaked its own proposal without gaining the assent of other EU states. The move has further poisoned the atmosphere, though officials played down the exit plans last night. The escalating brinkmanship between Athens and EMU's creditor powers came as European leaders gathered in Brussels last night for a "growth dinner", an agenda already overtaken by fast-moving events.
Disarray in Europe and fears of an unstoppable Greek exit sent markets into a tailspin. The FTSE 100 lost 2.53pc, and the German DAX dropped 2.3pc. Spain's IBEX slumped 3.3pc to a nine-year low. The euro tumbled almost a cent to $1.2566 against the dollar, the lowest since August 2010. Spain's 10-year bond yields jumped to 6.14pc.
The summit was a polite showdown between Germany and an emerging "Latin Bloc" led by France, Italy and Spain, determined to force a change in the Europe's strategic direction. The Latin coalition wants eurobonds to kickstart growth and mutualise debts, anathema to Germany, as well as EMU-wide deposit guarantees and an activist ECB. Chancellor Angela Merkel has ruled out eurobonds, although there could still be room for project bonds or short-term "euro-bills".
Spanish leader Mariano Rajoy warned that spiralling borrowing costs were pushing his country towards the brink. "Europe has to come up with an answer because we can't go on like this for long," he said. Mr Rajoy said austerity efforts were being overwhelmed by the force of the crisis, blaming the ECB for failure to contain contagion by capping yields.
"The policies that we Europeans believe in, such as controlling state spending and reforms to boost growth, ultimately have no effect," he said in Paris after a pre-summit tete-a-tete with French president Francois Hollande. Their encounter is itself evidence of Europe's changing dynamics, a break with the tradition of Franco-German axis.
Britain's David Cameron attacked at home for austerity policies is in the odd position of backing stimulus policies in Europe. "What we need is a decisive plan for Greece, and decisive plans to help get the European economies moving," he said before the dinner.
Christine Lagarde, head of the International Monetary Fund, ratcheted up the pressure on Greece, confirming that the fund was bracing for exit. "Officials must be prepared for all solutions," she said.
She said Greeks could not tear up the bail-out terms of the EU-IMF "Troika" and expect to stay in the euro. Yet she hinted that creditors might be willing to modify their loan terms to defuse the crisis and help Greece's pro-bail-out parties before elections on June 17. She said euro members "may consider the integrity of the zone to be more important".
Her comments reflect thinking in the Latin states, not Germany, which has a veto on aid payments. The issue may come to a head rapidly since Greece will run out of money for state operations by mid-June, due to falling tax revenues.
Fitch Ratings said the sums needed to keep Greece on track at this stage were "pretty small" compared with the sunk costs of past rescues. "The Greeks have not run out of bargaining power," it said.
David Riley, Fitch's managing-director, said it would downgrade all eurozone states if Greece left. Europe's policymakers would have to conjure a new regime for Euroland, and a quantum leap to fiscal union to restore credibility. "They couldn't simply shrug it off," he said.
