Markets hit as ECB plays hardball with Greece

The European Central Bank (ECB) has thrown a spanner in the works of Greece's debt negotiations this week, by restricting the financing available to the country's banks.

The announcement, made late Wednesday, has sent a shockwave through the world's markets and has left many analysts believing that the euro zone's central bank is playing hardball at a crucial time for not just Greece, but for the euro zone as a whole.

In Europe on Thursday, banking stocks across the region were down 1.3 percent in the morning session, weighing heavily on wider benchmarks. The sector recovered some ground to close down 0.5 percent on the day.

Greek stocks were down around 5 percent in afternoon trading, before closing over 3 percent lower. Greece's Bank of Piraeus lost 27 percent at the open, the National Bank of Greece was down 26 percent and Alpha Bank lost 13 percent

The rout in Europe's markets comes after U.S. stocks closed mostly lower Wednesday on the news, and dented global sentiment.

Read MoreECB:Banks can't use Greek debt as collateral

The euro also fell from around 1.141 against the U.S. dollar to close to 1.132 overnight, while the yield of Greece's 10-year sovereign bond rose above 11 percent again on Thursday morning.

CNBC takes a look at why the ECB acted as it did and what it means for Greece and Europe.

The waiver

Late Wednesday, the ECB revoked a waiver that allowed Greek banks to use the country's sovereign bonds as collateral for loans.

You could say that the ECB is technically just doing its job. The central bank can only accept investment-grade paper as collateral - which Greek sovereign debt isn't. But the timing of the announcement has surprised many market-watchers: The ECB is supposed to be politically neutral.

Greek banks can now only tap the liquidity funds provided by the Greek central bank which charges higher interest rates for the privilege. However, many analysts have noted that this was due to happen in March, regardless.

Nonetheless, the announcement is likely to severely restrict the refinancing options open to Greece's lenders and piles the pressure on the new Greek government and euro zone policymakers to reach a deal -- and quickly

"The steps announced (Wednesday) and the general tenor of the discussions has rightfully renewed concerns of a 'Grexit'," Dan Greenhaus, the chief strategist at BTIG, said in a note on Wednesday evening.

Blackmail?

Influential figures within Greece's new government have been on a whistle-stop tour of Europe this week as the new left-leaning Syriza Party aims to overhaul the nation's bailout program with European Institutions and alleviate its debt burden.

On Wednesday, Mario Draghi, the president of the ECB, met with Greek Finance Minister Yanis Varoufakis. On Thursday, Varoufakis will meet with Wolfgang Schäuble, his German counterpart, with the latter likely to urge Varoufakis to stick to current austerity plans, despite his pre-election promises.

Investors are concerned that if it cannot find an agreement, Greece will be forced into a default on its debt -- a move that will force the country out of the 19-country euro zone, further destabilizing the region's already-shaky economy.

The situation is made even more difficult by reports from Bloomberg on Wednesday, citing two people familiar with the country's financial position, that said Greece could run out of cash in March without help from the ECB.

The ECB has said that the decision was "in line with existing euro system rules," but Simon Derrick, chief currency strategist at BNY Mellon, believes that its hard to ignore the timing of the move.

"This seemed designed to send a very clear signal to the Greek government rather than anything else.The message itself is simple enough: there is little room for compromise in the upcoming negotiations," he said in a morning note.

How will Greece respond?

The pressure on the new Greek government to stick with the current bailout program has clearly increased with the ECB announcement, according to Carsten Brzeski, senior economist at ING.

"Whether the Greek government will be impressed, remains to be seen," he said in a note Thursday morning. "The heat is on."

Meanwhile, Varoufakis himself, gave his response overnight ahead of his trip to Berlin.

He said in statement that that the Greek government remains "unwavering" in its goals and said the decision puts pressure on the Eurogroup to proceed rapidly to conclude a "new mutually beneficial" agreement between Greece and its partners.

- By CNBC's Matt Clinch