Greece, France and the future of the euro

Financial markets were not surprised by the French or Greek election results, so they initially chose to be only mildly alarmed. But the more that investors and policymakers think about them, the more worried they are - for good reason.

Short term, at least, the most important thing that has happened in the past few days is that Greece has moved several steps closer to leaving the euro.

True, a majority of Greeks want to stay in the single currency. But this is not a one-off protest vote: they clearly do not want to stay in on the terms negotiated by the previous government, and the rest of the eurozone do not want to offer them better ones.

Greece and its eurozone partners have come close to the brink before, and always found a way to step backwards again. Experience would suggest they will do so again.

There's no evidence, after all, that a party committed to tearing up the terms of the rescue package can even form a government in Greece.

But you have to say the chances of a messy Greek exit are higher than they were a few months ago. And, let's face it, they were pretty high then.

Weeks without a government, probably leading to new elections, more uncertainty and a wrangle over the next IMF review in June - it all leaves plenty of room for accidents.

So, the rest of the eurozone finds itself once again needing to answer two questions:

First, do they have the tools and money to protect the rest of the European periphery from the fallout of a Greek exit?

And second, do they have an economic strategy that can offer those other troubled economies a way out of crisis, without leaving the single currency as well?

The answer to the first question is that they are much better prepared than they were 6 or 12 months ago - both psychologically and financially - to tackle the market contagion from a Greek exit.

Policymakers exaggerate both the size and the immediate usefulness of the enhanced 700bn-euro ($911bn; £564bn) European "firewall", which could be supplemented by the new money that has been lent to the IMF by Britain and other countries.

Even on paper, the funding now available would not be enough to cover the financing needs of all of the countries in the firing line for any length of time. But the war chest is much larger than it was.

And at least some thought has been given to how it could be deployed, at a pinch, particularly to shore up banks in countries like Spain.

The answer to the second question is that they have an economic strategy for getting out of this - but it's not one that any of the key players in the eurozone have a great deal of confidence in (with the possible exception of Chancellor Merkel).

What's changed in the last few weeks is that the ECB President, the incoming French President, the International Monetary Fund and the European Commission all now seem to agree that there needs to be a greater focus on "growth".

The bad news is that they completely disagree on what a more "growth-focused" approach would look like.

For ECB chief Mario Draghi (and the Italian president Mario Monti), it means deeper, faster structural reforms to free up labour markets, deregulate service sector industries and generally rein back the role of the state.

For Francois Hollande, it means looser fiscal and monetary policies, and a slower pace of structural reform (if any).

That, after all, is the platform he fought the election on, though it must be said, President Sarkozy had not been such a great champion of a smaller state. French public spending is now around 58% of GDP - by far the highest in the eurozone.

For the European Commission, it means a lot more references to the word growth in Brussels policy documents - and a lot of new European infrastructure projects which might well take years to get off the ground.

The IMF and the financial markets would probably like to see a combination of all of these: long-term structural reforms to free up economies and put government spending on a more sustainable path, combined with some short-term relief on austerity and (with luck) easier monetary policy as well.

If Chancellor Merkel could then agree to some form of mutalisation of eurozone government debt, well, a workable way out of the crisis might actually be in sight.

Does President Hollande's victory make it more likely that this miraculous deal might be struck?

One is tempted to say it is less likely, given Mr Hollande's rhetoric on the campaign trail.

This is not a man who seems to think France is crying out for difficult reform. He is a man who sounded for all the world like a man who would like to keep things more or less as they are, only with fewer spending cuts.

But, as I wrote here recently and discussed on the Today programme this morning, when you look at his policies, the difference between President Hollande and President Sarkozy looks a lot smaller.

He would delay the VAT rise due to come in the autumn. And he would balance the budget by 2017 rather than 2016.

But on paper, at least, there's a smaller gap between them than there was between Labour and the coalition in 2010.

You never know, if President Hollande and Chancellor Merkel are committed to making it work, the Franco-German relationship might actually do better with a less theatrical character running France.

The German Chancellor is under pressure herself after this weekend's disappointing local election results. And she wasn't President Sarkozy's greatest fan.

So, this weekend's events need not spell disaster for the eurozone. But they do spell a lot more uncertainty. For that reason alone, investors and policymakers are right to be nervous.