The possibility of Greece being forced out of the euro - the so-called 'Grexit' - increased this week after the country's voters rejected plans to reduce the country's debts. And a Greek departure from the euro could cause a £100bn hit to global banks and send further shockwaves through equity markets.
Greek pro-austerity parties won only 149 of the 300 parliamentary seats, a result which, says Ryan Hughes of Skandia, "significantly increases the chances of Greece leaving the euro". But analysts doubt whether the European Union-European Central Bank (ECB)-International Monetary Fund plan, which writes down some debt in exchange for huge public spending cuts, can be renegotiated. Joerg Asmussen, a member of the ECB's executive board said this week: "Greece needs to be aware that there are no alternatives to the agreed bailout programme if it wants to stay in the eurozone." And German politicians are opposed to lending Greece any more. A new deal, says Athanasios Vamvakidis of Bank of America Merrill Lynch, "is not an option".
While some are hoping that a grand coalition of pro-austerity parties and a few other MPs might be formed, it's more likely that there'll be fresh elections next month. Mr Hughes says these would effectively become a referendum on the country staying in the euro. Greeks are still in favour of this, in part because leaving the euro would give them a very weak currency, which would send imports soaring, thus cutting real incomes. Departure is thus not an alternative to austerity, but merely a different form of it. Some analysts hope that this prospect will force the one-third of voters who abstained on Sunday back to the pro-austerity parties.
But Mr Vamvakidis doubts that a second election would change things, and the country is on course to leave the euro. This would cause the country to default on both the government and private sector debt it owes non-Greeks, either because the debt would be repaid in almost worthless drachmas or because Greeks just couldn't afford to repay the euro-denominated debt. Such defaults could cost the world's banks over £100bn.
Perhaps even worse, a Greek exit would lead to speculation that Portugal or even Spain might follow. This could trigger runs upon their banks, as savers try to prevent their deposits being redenominated into weak, non-euro currencies. Even the small chance of this would tend to weaken the euro and be very bad for banking shares - and thus for equity markets generally.