The euro is under siege - and the next few days will be crucial.

Financial markets are betting heavily that Greece’s crushing debt could drag down the entire eurozone, and that could force reluctant EU leaders into an embarrassing bailout.

If EU leaders don’t take some kind of decisive action this week at their summit meeting, the euro could continue its slide - and Greece’s economic woes could spread to other flailing countries in the 16—nation eurozone like Portugal, Spain or even farther to heavily indebted Italy and Belgium.

“Thursday’s EU summit is the real litmus test,” said VTB Capital analyst Neil MacKinnon. “If it fails to come up with any debt restructuring package or a quasi-bailout, then the pressure on the euro will increase.”

Investors have turned increasingly pessimistic on the outlook for the euro, so much so that speculative traders’ short positions, or bets against the single currency, have reached a record, said Mr. MacKinnon.

While some of those short trades, reported by the U.S. Commodity Futures Trading Commission, will have been unwound - the euro was in fact up somewhat on Tuesday - the data suggests market sentiment is at a turning point.

On Tuesday, a new commission - the EU government - was formally approved by the European parliament, and must immediately confront a gathering sense that the euro’s fundamental weakness - no common fiscal policy for its wildly diverse economies - has been exposed.

The European Union’s own government-backed lender said on Tuesday that its rules do not permit it to bail out Greece or any other European country that can’t pay its debts, narrowing leaders’ options.

The euro is now trading near an eight-month low against the U.S. dollar on worries about Greece. European stocks inched up on Tuesday, and the euro rose by three-quarters of a cent to $1.3725, on speculation that heads of state and government will have to announce something at Thursday’s summit. The euro was as high as $1.51 in December.

The bounce followed news that European Central Bank President Jean-Claude Trichet had left a banking conference in Australia to attend the summit, stoking expectations of some kind of backstop for Greece.

Some were skeptical the meeting could stop the slide in sentiment. “To be sure, markets will be looking to Thursday’s EU leaders’s meeting for answers, but we’d be greatly surprised if those meetings concluded in a manner which diminished market concerns about the matter.”

Jittery markets are piling the pressure on EU nations to state clearly what they would do if a euro member is likely to default. Officials have not managed to calm these market worries with repeated assurances from both the EU and the Greek government that Greece can pull itself out of its debt crisis with a harsh austerity program of cuts to public spending that have already triggered strikes and protests.

A bailout could be expensive, but a default would be worse. In any case, market skepticism about government finances could mean Greece and other troubled countries will have to pay higher interest rates to borrow, making it even harder to dig themselves out of trouble.

The crisis shows one of the vulnerabilities of the 10-year old currency union, in that it lacks an effective central authority to enforce limits budget spending. With budgets in the hands of 16 separate governments, the euro relies on a set of rules limiting deficits to 3 percent of gross domestic product. Large deficits can undermine a currency.

Greek Prime Minister George Papandreou held government talks on Tuesday on accelerating those cuts with reforms to pensions and wages - an effort to prove to markets that Greece can and will make long-term spending reductions and not need a bailout.

The EU’s executive commission has backed the Greek programme and says no bailout will be needed. European Union nations say the same, rejecting reports that they are talking about possible bailout plans.

The bailout options are limited - but not impossible.

European Union agencies - such as the European Commission - can’t take on debt for governments. Neither can the EIB, it said. It has euro75 billion ($103 billion) to lend for infrastructure and economy projects, usually in poorer EU nations.

Three EU members that don’t use the euro - Hungary, Latvia and Romania - have secured bailouts from the International Monetary Fund and the EU. But EU officials say that IMF help won’t be needed for a euro country.

That leaves the ball in the court of EU governments. Legally, governments can do it if a member state “is seriously threatened with severe difficulties caused by ... exceptional occurrences beyond its control.”

What remains is deciding how to do it - and what taking on Greek debt could do to richer nations.

EU governments could cut the costs of Greek spreads overnight by agreeing to jointly underwrite Greece’s debt - but this could hike the cost of their own borrowings.

They could also provide a loan to Greece - but it is uncertain that they could or would provide enough to give Greece some long-term relief. Greece is looking to borrow some euro51 billion from bond markets to pledge its budget gap this year.

Another option would be bonds, issued jointly by European governments to raise money from markets. EU and ECB officials have talked this down but European socialists are keen - including Greece’s current government - because it could ease harsh spending cuts.

What is clear is that EU governments do not want to let Greece off the hook - and that any option would force Greece to make long-delayed reforms to rife tax evasion, rigid labour market rules and an inefficient and high-spending pension and health care system.