Morgan Stanley fears German exit from EMU

"The backstop package for Greece and the ECB's climb-down on its collateral rules set a bad precedent for other euro area states and make it more likely that the euro area degenerates into a zone of fiscal profligacy, currency weakness, and higher inflationary pressures over time," said Joachim Fels, head of research, in a note to clients.

The US bank said a bail-out for Greece may be necessary to avoid a crisis for Europe's financial system, but warned that it also "sows the seeds for potentially even bigger problems further down the road".

Mr Fels said weak states cannot easily leave EMU because they would pay a stiff penalty in higher rates, would be stuck with euro debt contracts, and might need controls to stem capital flight. It is a different calculus for Germany, which would see lower rates and might view EMU exit as the only way to ensure monetary stability. (more)