Forget the markets and the Greek election. The most important poll is under way in the European Cup where the basket cases seem to be having the best run, outdistancing all but one of the hardliners.

Bailed-out countries led by Greece, followed by Portugal, Spain and Italy, are dominating the competition. This Friday night sees Greece (shock winners in 2004) surprisingly into the quarter finals where they will play the favourite, Germany. That will be the game of the tournament. But Italy, Portugal and Spain are through as well — only Ireland didn’t make it from the bailouts. Recessionistas France and England also seem to be on track, the former plays Sweden (which is out — call it “Assange’s revenge”); the latter, possibly stirred on by Mervyn King tipping another $100 billion into the flagging UK economy, plays co-host Ukraine. Axis of austerity member Holland has flopped badly. Only hard money Germany is there holding aloft the flag of austerity, well organised football and doubtless a strict policy of no stimulants.

You’ll have better luck wagering on 22 blokes chasing a ball around a rectangle than the markets: the surge in markets in Australia and Asia yesterday died within an hour of European trading opening. For the second time in a week, a Monday rally was snuffed out by the reality that is Europe, and Spain, not Greece. But inconveniently for our exporters, the fading in the rally was selective: the Aussie dollar twice hit five-week highs of $US1.027 early today. If market sentiment had been really weak, then the Aussie dollar would have weakened, as it has done up to last Friday when it regained parity.

All it took was a small note of reality, a troubling statement, statistic or observation, to break the rally. Overnight, the central bank of Spain revealed, in a monthly report, that non-performing loans held by the country’s banks had hit an 18-year high of 8.72%. With banks expected to hold about 8% of good capital under the latest capital rules, that means many of Spain’s banks are close to, if not insolvent, hence the belief that last weekend’s €100 billion of aid (which prompted another failed rally) would not be enough.

As a result, yields on Spanish 10-year sovereign bonds jumped to 7.28%, an all-time high and 10-year Italian bond yields reached 6.03% in “sympathy”. With Spain set to try and sell €2-3 billion  of 18- month bonds tonight our time and one to two billion of unspecified bonds on Thursday, the sense of relief about the eurozone following the Greek poll has gone and fear and loathing has returned.

While markets continue to bounce and sag, seemingly on an hourly basis, the austeristas are slowly losing their grip and, it seems, will continue to do so. Look at the change in attitude at the International Monetary Fund: in a statement released at the G-20 meeting in Mexico, the fund urged Europe to leave no stone unturned to encourage economic growth. “A revival of growth seems key to reversing the vicious cycle of poor confidence, flagging growth, fiscal weakness and bank vulnerability,” said the IMF’s report, released as the Group of 20 leaders met.

The IMF said that Germany and other northern European countries should tolerate higher inflation to reverse the competitiveness gap between the north and the south of the eurozone (we won’t bother to invoke the great cliché of European economic commentary, the German terror of inflation, Hitler, the war, etc). Because the region overall depends heavily on bank credit, bank restructuring should be encouraged, the fund said, including through foreign direct investment. The fund made it clear it was not simply calling for stimulus, and that rapid budget cuts should continue to take place in countries where market pressures are severe and more slowly where such pressures are less acute.

“The analysis shows large-scale reforms could boost GDP by 4.5% over five years. A quarter of this gain would come from countries coordinating reforms and acting together. This demonstrates the importance of a concerted approach, although each country will need to design its own agenda to tackle specific priorities.”

“The IMF said half of these gains, roughly 2¼ percent, could come from product and service market reforms, underlining the importance of tackling vested interests in sectors such as distribution and regulated professions. The north should focus on increasing labor participation and improve services efficiency, while the south urgently needs better functioning labor markets.”

So the pain has to be shared, not just concentrated in the bailout economies. That will throw the Bundesbank in Germany into a tizz, as well as all those in France, Greece, Spain, Italy and elsewhere who believe there should no reforms or change and pine for a retreat back to the bad old days of sloth, graft, greed for unions, professions, politicians and businesses.

Where’s Greece in all this? Greece is now a sideshow, despite all that talk of “Lehman” moments. It can still disrupt markets, but the once nightmare scenario of default and a return to the drachma are now accepted as the likely future for the country. Markets have had time to adjust. Which means Spain and Italy are now the problems that interrupt those watching the football.

The new government in Greece is yet to be formed and the chat is that the best the new government can expect on changes to the bailout is a doubling in the time for €11.4 billion of budget and spending cuts to four years, from the current two years.

There was also a report in Ireland that the EU and IMF are considering doubling the repayment term of its €85 billion bailout to 30 years from 15. The story was reported by state broadcaster RTE and could be a case of wishful thinking after the Greek vote and suggestions of a softening in its bailout package. Perhaps that’s why Portugal’s Economy Minister Alvaro Santos Pereira said overnight his country has liquidity problems, as a way of raising his hand for more money or an easing in its bailout terms might be on the cards.

Early Thursday morning Europe will be forgotten as markets focus on the US Federal Reserve’s post-meeting statement. It’s widely expected to reveal a third round of quantitative easing. That may be the market getting ahead of itself as it has done before but the talk is getting louder. Overnight, several economists and investment banks predicted an extension of the current easing, called Operation Twist (which sees the Fed selling short-dated US government bonds and buying longer-dated securities to drive down short-term rates on mortgages). reported that analysts at French bank Societe Generale forecast an extension with its head of global economics, Michala Marcussen, saying she expects the Federal Reserve’s asset-buying program to be directed 40% at mortgage-backed securities and 60% towards US Treasuries. “With economic data signalling stall speed growth for the US, we expect the Fed to lower its current 2012 growth outlook from 2.7%, narrowing the gap to our own forecast of 1.8%,” Marcussen said. She added the Federal Reserve could also extend its Operation Twist program, expanding it by $150 billion. “We now expect the Fed to ease policy further at next week’s meeting,” Barclays Capital economist Dean Maki said in a note to clients. “We see a short-term extension of Operation Twist as the most likely outcome.”

If this doesn’t happen, then expect a market tanty (if it does happen, watch for more whingeing from Republicans about the Fed “printing money” and other nonsense). If there is a new easing, then we will get a relief rally, until the next bit of bad or unwanted news. But the European Cup will be worth watching, especially Greece versus Germany on Friday night. A win for the Greeks would do more for national morale than new terms for the bailout package!