Europe's biggest financial powers have worked themselves into a standoff over how to haul Greece out of its debt ditch, with the European Central Bank publicly opposing Germany's demand to make Greece's private creditors share the burden.
The impasse _ which pits the region's top monetary authority against its economic powerhouse and bankroller _ has unnerved markets as each side seems to have dug into positions that will be difficult to reconcile.
Someone will have to back down by the end of the month, when officials will need to agree on more aid for Greece to keep it afloat. Officials say Greece's funding needs to be secured a year in advance for the International Monetary fund to pay its part of Greece's next loan installment, due June 29.
Because Greece is still short of money despite last year's euro110 billion rescue package, it will need more loans.
But Germany's parliament on Friday backed demands from Finance Minister Wolfgang Schaeuble that Greece only get more rescue loans if investors agree to get repaid seven years late on their Greek bonds. That would give the country more time to get a handle on its euro340 billion in debt.
"The situation in Greece and therefore in Europe as a whole is serious," Schaeuble told deputies. He warned that without agreement on how to keep aid flowing to Greece there was "an acute danger of Greece being unable to pay its debts, with grave consequences for the euro area."
Germany's demand on bondholders is a key condition to rally support among the public and lawmakers in Chancellor Angela Merkel's coalition, some of whom are restless at the idea of giving Greece more money.
The vote is a gesture of support for Schaeuble as he gets ready for a June 20 meeting of finance ministers on more aid for Greece.
Facing off against Schaeuble at that meeting will be Jean-Claude Trichet, the head of the ECB, who says Greece must not change the terms of its debt in ways that put it in official default.
Ratings agencies have said that a bond repayment that materially disadvantages bondholders would be considered a default. Germany has remained vague about key details, such as interest rates and any collateral provisions, but it is hard to see how bondholders could voluntarily agree to an extension on their bonds given the clear risk of default.
"No credit event," Trichet repeated at his monthly news conference Thursday when asked about the German demand, using the technical term for a default ruling by credit agencies. Anything that brings that on would be "an enormous mistake," he said.
The euro slid in the wake of his remarks and uncompromising tone.
The banks says that any kind of default could worsen the financial crisis and spread market turmoil. Greece, Portugal and Ireland have all been bailed out by the European Union and the International Monetary Fund after bond markets refused to lend them money at anything but exorbitant interest rates.
Schaeuble said he took the ECB's warnings "very seriously." He added a group of officials from the IMF, ECB and the European Union's executive Commission would work to find the "fine line between quantifiable participation by the private sector and avoiding negative consequences on financial markets."
He said a solution would have to be supported by the ECB.
Yet ratings agencies have made clear that it will be difficult to craft a change in the terms of Greece's debt that does not lead to a ruling of default. Key elements are whether any change costs bond holders money, not just in lost principal but in foregoing higher rates of interest as well.
A default rating on Greece would put the ECB, and Greek banks, in a very tough spot, since the ECB says it will in that case no longer take Greek government bonds as collateral for emergency loans to banks. That could bring down Greece's banks _ an outcome so catastrophic that economists openly dismiss the possibility the ECB would carry through on such a threat.
Joerg Kraemer, chief economist at Commerzbank, said markets were taken aback by Trichet's vehemence.
"It is by no means certain that the ECB could act on its implicit threat to allow the Greek banking system to collapse by cutting off liquidity if worse came to worst," Kraemer said. "The fact that Trichet nevertheless showed himself so resolute demonstrates the ECB's resolve."
Kraemer said Germany may be the first to ease its stance, adding European finance ministers would probably approve further loans for Greece along with "vague calls for investors to remain invested in Greece." He said there would probably be no default.
"However, it cannot be entirely ruled out that the politicians will ignore the ECB's warnings and compel the central bank to stop providing liquidity," he added. That risk was probably why the euro as dipped since Trichet's comments on Thursday and Schaeuble's insistence on his position Friday.
Some analysts think that, by not ruling out a voluntary debt exchange or rollover by investors, the ECB is subtly leaving itself room in case it has to retreat.
"The ECB's implied acceptance, or lack of complete exclusion, of what is described as a purely voluntary agreement, was perhaps the first indication we have had that there is some form of debt reprofiling or rollover or rescheduling _ or whatever you want to call it _ which might be acceptable to it," said Jonathan Loynes, chief European economist at Capital Economics in London.
In the near term, someone will have to yield, said Loynes.
"The sides in this standoff are not going to let Greece run out of money with devastating financial effects over the entire region," he said.
In the longer term, a Greek restructuring _ and not a voluntary one _ is likely, he said. "Ultimately, I think the ECB will have to back down or it will be overruled. One way or other, I am convinced there will need to be a fairly major form of Greek debt restructuring, probably not voluntary."