(MoneyWatch) The European Central Bank's suggestion last week that it will take whatever steps are necessary to save the eurozone, along with a tentative agreement between Greece and its lenders, may mean an August vacation from financial "contagion" in Europe.
But while that is likely to temporarily quiet the region's debt crisis, it will leave little time to come up a longer term remedy by year's end. That could leave Europe face its most challenging September since 1939.
For now, the financial markets seem to have calmed down following comments last week by ECB chief Mario Draghi. Using the indirect language favored by the heads of central banks around the world, he said the bank "may undertake outright open market operations of a size adequate to reach its objective." Draghi added that European Union officials should "stand ready" to also use their bailout fund in the bond market.
Investors had been hoping Draghi would promise to intervene in the bond markets, and their initial reaction to this was clearly fear-driven. Spain's borrowing costs shot up past the critical 7 percent mark. Since then, it appears financial markets have re-interpreted his comments to mean that the ECB will, after a period of preparation, take action. As a result, borrowing costs are down again for Spain and Italy, Europe's two largest troubled economies.
That preparation will not be easy. It chiefly consists of getting the German government to agree to loan money directly to Italy and Spain. Germany, with Europe's largest economy, can effectively veto any ECB move. German officials and voters have long opposed this kind of action. Greece's inability to re-start its economy following two bailouts has only served to harden that opinion.
Although Greece is no longer the focal point of Europe's financial crisis, it is still a major trouble-spot. A Greek default and exit from the European Union would be at best tumultuous and could prove disastrous. The nation has so far been unable to meet the reductions in government spending required by the ECB, European Commission, and International Monetary Fund as a condition for funding aimed at preventing a Greek default.
These problems have raised doubts about whether Greece would continue to get funding from the "troika." The country risks running out of money without the disbursement of $5.2 billion that was initially due in June as the first installment of a $38.5 billion transfer.
However, hopeful signs emerged this weekend following two weeks of meetings between Greek government ministers and troika representatives. IMF envoy Poul Thomsen said there had been "great progress" in finalizing a package of $14.2 billion in budget cuts for 2013 and 2014. The talks are scheduled to continue in September.
Thomsen's comments may have been aimed at bolstering investor confidence and giving Greece a chance to borrow money on the international markets. The Greek newspaper Ekathimerini reported last week that Athens on Tuesday plans to sell $776 million in 26-week Treasury bills. The country is hoping to sell $7.2 billion of such bills this month, $2.4 billion more than initially planned, and tap bank recapitalization funds in order to cover its financing needs. The government needs to raise money to pay $3.9 billion of redemptions for bonds held by the ECB that mature Aug. 20.
Next month is already shaping up as a time that will test investors' nerves. Two things are supposed to happen that will go far in determining the condition of Europe's economy. One is the next planned payment from the troika to Greece, which has been put off before. The other is the scheduled release of an independent audit of Spain's banks. The audit's release has already been postponed several times since the original June date.