News that Germany and France are ready to stand by Greece and avoid it leaving the euro helped stocks to rally following a conference call between Angela Merkel, Nicolas Sarkozy and Greek Prime Minister George Papandreou on Wednesday.
As statements of intent go, this one did not sound that different from the hundreds we have heard over the last two years, but stocks rallied nonethelesson hopes that some kind of coordinated action is on the cards.
"Putting into place commitments of the program is essential for the Greek economy to return to a path of lasting and balanced growth,” the Greek finance ministry said in a statement adding that the IMFis now likely to hand over the next tranche of aid to Athens.
US Treasury Secretary Tim Geithner, who travels to Poland on Friday to meet euro zone finance ministers to voice President Barack Obama’s frustration with a lack of leadership in the euro zone, has added to the sense that Europe may be about to attempt to put its house in order.
"They recognize that they have been behind the curve. They recognize that it will take more force behind their commitments," Geithner told CNBC in New York on Wednesday.
Following days of heavy losses for some European banks and the downgrade of Societe Generale and Credit Agricole , investors where buoyed by the message from Geithner.
"There is no chance that the major countries of Europe will let their institutions be at risk in the eyes of the market. There is not a chance,” Geithner said in the interview.
In Rome, Italy’s parliament gave final approval for Silvio Berlusconi’s 54 billion euros ($74 billion) austerity program. This is another positive for the euro zone but the protests outside and pictures of lawmakers being man-handled by angry voters remind us that the policies being demanded are not popular with electorates around Europe.
Soothing words from politicians and a positive vote on the austerity package in Rome do not change the fact that the problems in Greece remain immense and risk dragging the euro zone into a major crisis. Tensions are high, funding for banks remain a huge concern and if you raise hopes you also run the risk of disappointing raised expectations.
The scale of the problem facing the euro will be made clear to EU finance ministers and Tim Geithner on Friday in a document warning that Europe faces another credit crunch. According to Reuters who have obtained a copy of a report put together by EU officials, finance ministers will be warned that the risks are very high.
"While tensions in sovereign debt markets have intensified and bank funding risks have increased over the summer, contagion has spread across markets and countries and the crisis has become systemic” said the document seen by Reuters. "A further reinforcement of bank resources is advisable.”
George Soros, the legendary investor who beat the Bank of England when the UK was forced out of the ERM in the 1990s, warned European leaders they need to create a euro zone Treasury if they are to avoid a depression.
"It appears the authorities have reached the end of the road with their policy of 'kicking the can down the road,'” said Soros in an article for the New York Review of Books on Wednesday.
"Even if a catastrophe can be avoided, one thing is certain: the pressure to reduce deficits will push the euro zone into prolonged recession. This will have incalculable political consequences," he added.
Soros believes the EU needs to prepare for default and the exit from the euro of Greece, Ireland and Portugal and believes four policy responses are needed immediately.
These are guaranteeing bank deposits to avoid bank runs in weaker states , support for the euro zone banking industry and recapitalizationand euro zone supervision plus support for weaker euro zone member’s bond markets.
"Once the principle of setting up a European Treasury is agreed upon, the European Council could authorize the ECB to step into the breach, indemnifying the ECB in advance against risks to its solvency,” Soros explained.
"That is the only way to forestall a possible financial meltdown and another Great Depression,” he added.
If the euro zone is to raise hopes that a solution to the crisis is about to be agreed, then its leaders would do well not to disappoint.