World markets are poised as the fate of the eurozone enters another important week.
Nicolas Sarkozy and Angela Merkel met on Monday to begin the process of renegotiating the core treaties of the EU and bring the euro back from the brink of collapse.
Markets in Europe climbed 8.5% last week, after coordinated central bank action to inject money into the international markets caused a global liquidity-driven rally. On Monday, that optimism was still on show, with the main European indices opening higher, driven by an announcement of an austerity package in Italy and rumours over the weekend that the European Central Bank (ECB) stands poised to print up to €1tr (£860bn) to buy up government debt and support banks in the eurozone.
Monday's meeting between the euro's two largest economies sets the stage for a week of drama ending with an EU leaders summit on Friday. US Treasury Secretary Timothy Geithner arrives in Germany on Tuesday, and will spend three days meeting with leaders of European countries and institutions. The ECB meets on Thursday, with the markets listening for any signs that it might be ready to intervene, although if the president, Mario Draghi, sticks to the form guide, he will be unlikely to pre-empt the politics and offer any hints.
The ECB is already propping up the sovereign bond markets, buying up Italian and Spanish debt to keep the yields - the amount of interest that investors demand to buy the bonds - down to more manageable levels. However, the bank has been resistant to playing a more prominent role in bailouts, with Draghi having reiterated that his role is not to finance governments.
Germany has also been resistant to using the ECB "bazooka", which would increase the inflationary pressures on the eurozone and throw good money after bad, by giving support to the weaker peripheral economies without any penalties should they fail to stick to budget targets.
The so-called "moral hazard" of bailouts without conditions has been a feature of the German rhetoric since the beginning of the current crisis, and formalising ways to punish countries who are fiscally irresponsible has been the Merkel government's main demand in negotiations.
This is now very much on the table. The French and German positions may differ, but the need to agree on some form of fiscal union, with the size of budget deficits and public spending reined in by rules dictated by Brussels - and formulated in Berlin - is increasingly seen as the only real, long-term solution to the very immediate crisis.
The sequencing of events is important. Getting the rules right on Friday clears the ECB's line of fire, potentially setting in motion a fuller crisis response that addresses short term funding, creates a tighter economic framework to partially fix the mismatch between the eurozone's monetary policy and its economic diversity.
“A mutation of the ECB from a passive to an active purchaser might help in the short term. However, printing money just postpones the problem into the future, Asoka Wöhrmann, chief investment officer at DWS Investments in Germany, wrote in an outlook note on Monday.
“A sustainable solution requires a clear and transparent agreement on fiscal policy between the 17 countries, including ultimate rights to intervene if standards are breached. Only then can the ECB step in with an interim solution if it becomes necessary."
Press reports in Germany have also suggested that the 17 eurozone states could pour hundreds of billions of euros into a special vehicle to be invested through the International Monetary Fund (IMF).
Eurobonds - issued collectively by the member states - are another option to finance bailouts for struggling countries that have been much discussed and much dismissed, but remain plausible at the margin.
The markets remain relatively buoyant on surprisingly positive newsflow, but with the scale of the problems left to resolve and the survival of the single currency at stake, the week could see big swings in confidence.
"Irrespective of which direction the debate on unravelling the Euro-zone’s Gordian Knot has taken, it has met an impasse, with progress only plausible in the event of seismic political shifts," BNY Mellon strategist Neil Mellor wrote.