The impact of a Greek exit from the euro zone would be substantial but "manageable", Germany's Bundesbank said on Wednesday, raising pressure on Athens to keep its painful economic reforms on track.
In a toughly worded monthly report, the German central bank also said euro zone member states should have a say on further payments of aid to Greece under its 130 billion euro bailout program funded by the IMF and the European Union.
"Greece is threatening not to implement the reform and consolidation measures that were agreed in return for the large-scale aid programs," the Bundesbank said.
"This jeopardizes the continued provision of assistance. Greece would have to bear the consequences of such a scenario. The challenges this would create for the euro area and for Germany would be considerable but manageable given prudent crisis management."
Echoing German political leaders, the Bundesbank warned against Europe easing the conditions for Greece to access aid.
"A significant dilution of existing agreements would damage confidence in all euro area agreements and treaties and strongly weaken incentives for national reform," it said.
Greece holds a second election on June 17 after a previous poll produced a parliament split between supporters and opponents of the bailout program, which requires Athens to make deep spending cuts and hike taxes.
Anti-bailout parties are expected to repeat their strong performance, opinion polls show, increasing the risk that Greece will renege on its austerity pledges, default on its debt and possibly leave the single currency.
The Bundesbank said the Eurosystem of euro zone central banks had assumed "considerable risks" by providing Greece with large amounts of liquidity.
"In light of the current situation, it should not significantly increase these risks," the bank said.
"Instead, the parliaments and governments of the member states should decide on the manner in which any further financial assistance is provided and therefore whether the associated risks should be assumed."
German Finance Minister Wolfgang Schaeuble reiterated on Wednesday Berlin's insistence that Greece take its austerity medicine in order to regain competitiveness and resume growth.
"The Greek people must install a competent government," he told German radio. "(The austerity measures) are agreed not because we want to punish the Greeks but because they are necessary."
The Bundesbank said in its report that it would be crucial to phase out the euro zone's non-standard monetary policy measures in the future, to contain the risks arising from them such as distorting competition in the banking sector or inciting the delaying of structural reforms.
The Bundesbank said Germany's economic upswing would continue in the second quarter, driven by construction and consumption, while the manufacturing sector would "probably only make a comparatively small contribution".
"In light of all this, calls on German fiscal policymakers to loosen their fiscal policy stance in order to stimulate the economy appear inappropriate," the bank said.
"Attempting to kick-start the economy in the short term and putting off consolidation efforts in the long term are not conducive to regaining lost confidence."
This week, the Paris-based Organisation for Economic Co-operation and Development (OECD) raised its growth forecast for Germany this year to 1.2 percent and to 2.0 percent in 2013 on the back of strong domestic demand and a buoyant labor market in Europe's largest economy.