Euro zone leaders are as far as ever from finding a lasting solution to the bloc's underlying problem of economic divergence, despite their latest progress in managing the symptoms of its debt crisis.
The complex agreement reached in Brussels in the early hours of Thursday lends credence to the view that the euro zone will somehow muddle through. But it is not the Grand Plan that optimists had hoped for: what was the 14th summit in less than two years to tackle the crisis will not be the last.
This is another step in the right direction, but it is not enough to get us to the end game, said Stephane Deo, chief European economist at UBS. It buys time but it does not address the fundamental problem of the sovereign debt crisis.
European equities and the euro rallied after the summit exceeded markets' modest expectations. Banks agreed in principle to a 50 percent reduction in the face value of their Greek bonds and leaders said they intended to increase the firepower of their financial rescue fund to 1 trillion euros ($1.4 trillion).
But nearly 35 percent of Greek bonds is in the hands of public institutions such as the European Central Bank (ECB) and is not subject to the mooted writedown. As a result, Greece's debt would still be an eye-watering 120 percent of gross domestic product in 2020 -- exactly the level of late 2009.
And even that assumes decent economic growth and ambitious structural reforms including large-scale privatization of state assets.
From the macroeconomic point of view, if it's purely a 50 percent 'haircut' on the nominal bonds, without an extension of the maturity and a reduction of the coupon, I'd still be reasonably suspicious about the sustainability of Greek debt, Deo said.
REASONS FOR SCEPTICISM
Greece, however, has become something of a sideshow. Investors long ago judged that it was not just illiquid, but insolvent. Much more critical is what the euro zone could do to prevent the debt rot from spreading to bigger, systemically important but stagnant economies, notably Italy.
Markets will have to wait for details as to how the European Financial Stability Facility will be scaled up; whether the likes of China will top up the bailout fund; and how operationally it will enhance the credit of member states' new bonds.
But some analysts are skeptical. Economists at Royal Bank of Scotland said they expected markets to reprice sovereign debt across the euro area given the size of the losses imposed on Greece.
Expressed as the net present value of the bonds, the proposed loss will be close to 70 percent, much more than the 40 percent hit that banks had volunteered to take, RBS said.
What's more, the EFSF will be too small to offer help to any country that might need it for any length of time. And a promise by governments to help banks regain access to long-term bond market funding implies they will have to assume extra contingent liabilities, thus adding to their debt burdens.
We find no convincing arguments in the new policy response to suggest that sovereign bond spreads in the euro area will tighten meaningfully vis-a-vis-Germany, RBS said in a note.
Italian 10-year bond yields did in fact fall 11 basis points on Thursday to 5.81 percent. But they were still around 30 basis points higher than in early October when the leaders of Germany and France promised a far-reaching solution to the debt crisis.
Yet another source of doubt involves the European Central Bank. Economists interpreted comments made on Wednesday by Mario Draghi, who takes over the helm of the ECB on November 1, as indicating that the bank will continue to buy Spanish and Italian government bonds in the secondary market if need be.
But investors, as ever, are demanding greater certainty.
If the ECB hands over its bond-buying responsibilities to the EFSF, there will be concerns that the rescue fund is not big enough for the job, said Karen Ward with HSBC.
Ultimately there are only two options for creating a firewall: the ECB's balance sheet, or the German balance sheet. If the ECB is not the backstop, it is unlikely the firewall can be big enough to be credible, Ward said in a note to clients.
Having the ECB act as a fully fledged lender of last resort, just as the U.S. Federal Reserve did during the 2008 financial meltdown, is anathema to Germany, which fears it would reward feckless debtors and sow the seeds of inflation.
But in dodging the question, euro zone leaders had squandered the chance to get ahead of the market, said Nicholas Spiro, managing director of Spiro Sovereign Strategy, a London consultancy.
They have not fixed the issue that investors care the most about: can you put in place a credible and durable and effective backstop for euro zone public debt? Spiro said.
We're not talking about working monetary union work. That's for the medium term. We're talking about containing the contagion. And they haven't been able to do that yet, he added. Credibility and confidence in Europe are all, and this has yet to be restored as far as I can see.
ALL EYES ON ITALY
The country most at risk of contagion is Italy, where anemic economic growth and faltering confidence in Prime Minister Silvio Berlusconi are compounding the difficulty of servicing a debt-to-GDP ratio of nearly 120 percent.
Under pressure from his euro zone partners, Berlusconi gave a raft of reform commitments at the summit, including raising the retirement age by two years, to 67, by 2026.
Not only do such deep-seated policy shifts take years to have an economic impact, they are highly contentious politically. Postponing the retirement age is so fiercely opposed by Berlusconi's ally the Northern League that it could topple his coalition government, Royal Bank of Scotland said.
And, as with Greece, the euro zone is proposing that the European Commission, the European Union's executive arm, take a more active role in monitoring the implementation of Italy's reforms.
Italy's biggest trade union, CGIL, wasted no time in pledging to fight the reforms and urged smaller unions to unite against targeted attacks on Italian workers.
Its call to arms highlights the risk that the euro zone's northern creditors, led by Germany, are perceived as infringing the sovereignty of southern states by demanding untenable terms in return for their financial aid.
Political strains already apparent can only get worse in the absence of a strategy for breaking a vicious cycle of budget cuts sapping economic growth and forcing ever deeper austerity.
Gavekal, a Hong Kong research outfit, called the overnight deal uninspiring and ambiguous and said it would be impossible for the euro zone to produce a convincing fiscal and political solution for at least another year.
At some point down the line, however, we will either have prosperity caused by economic integration and reform or political revolutions caused by denial of democracy, the firm said in a note to clients.
($1 = 0.724 Euros)
(Reporting by Alan Wheatley; Editing by Ruth Pitchford)