ROME, Nov 30 - It is a measure of the gravity of the euro zone debt crisis that Italy's bond auction results were greeted with relief on Tuesday, despite yields soaring towards a punishing 8 percent.
The markets were simply happy that Italy had managed to sell the three- and 10-year bonds without difficulty, with the 7.5 billion euros raised near the top of the Treasury's target range of 5-8 billion.
Great relief, it's all done, said Marc Ostwald, a strategist at Monument Securities, after the auction.
From one point of view we are better off than Germany, because we manage to sell all our bonds, said Italian daily La Stampa, referring to a German bund auction last week that attracted scant demand, though it offered less than a third of Italy's returns.
The reaction partly reflects the fact that the level at which Italy's debt becomes unmanageable depends much more on sentiment than on economics.
But it also shows that investors now see every Italian bond auction as a potential disaster that could signal the euro zone's third-largest economy has lost access to the markets.
In this context, the yield itself has become of secondary importance even though borrowing costs have shot above the 7 percent threshold that forced Ireland, Greece and Portugal to seek international bailouts.
As Italian yields have risen since the summer, 7 percent has often been described as a sort of red line in the search for a level at which government finances become unsustainable.
This was based more on the experience of previous countries rather than economics, and some analysts say Italy may continue to attract demand for its bonds even with yields at this level.
For one thing, a far higher proportion of Italian debt -- more than 50 percent -- is held by domestic investors, who are less likely to abandon auctions than foreign ones.
Italy also has a traditionally far more liquid debt market than Ireland, Greece or Portugal, offers a greater variety of debt instruments and has a far bigger economy.
Analysts agree that Italy's debt was already unsustainable in the long term at 6 percent but, if market sentiment holds, it could be sustained for months at 8 percent.
I think Italy will keep issuing debt and meeting demand targets, said Fabio Fois of Barclays Capital. The wealth of the country is very different to Ireland or Portugal so I think investors will demand high yields for a while before they abandon the auctions.
But can Italy afford these yields?
Analysts say that for at least a year it probably can, though the economic cost would be significant and the strain obviously increases the longer they remain so high.
The average maturity of Italy's debt is relatively long at seven years, meaning new debt issued at current yield levels has only a marginal and gradual impact on overall debt-servicing costs.
According to the Bank of Italy, even with zero economic growth for the next three years and yields of 8 percent, Italy's debt-to-GDP ratio would remain stable at its current massive level of 120 percent of output.
Gary Jenkins of Evolution Securities calculated that for Italy to refinance maturing debt in 2012 at current yields would cost 13 billion euros -- or 0.8 percent of output -- more than under Rome's most recent official estimates.
High yields just add to the financial burden for a country that has already approved around 60 billion euros of austerity measures over the next two years and is preparing more even though the economy is probably already in recession and is expected to contract in 2012.
Nicholas Spiro of debt consultancy Spiro Sovereign Strategy and Riccardo Barbieri of Mizuho bank said that from a strictly financial point of view Italy could continue paying current yields for at least a year.
But the crucial variable of market sentiment meant things must improve in the next few weeks or they would almost certainly get suddenly worse.
We are at a tipping point and it won't take much for this to cascade out of control, with spiralling yields and a buyers' strike, Spiro said.
Barbieri said Italian yields, and possible disaster, were less dependent on internal events than external ones, such as a possibly disappointing outcome of a European leaders' summit aimed at tackling the debt crisis on December 9.
There is a wide consensus that Italy has now become a proxy for euro zone risk and developments have long been driven by events far more than country-specific fundamentals or mathematical calculations of debt sustainability.
Without a credible backstop in place by the end of the year any number of factors, such as a bank crisis or a failed auction could pull the rug on Italy, said Spiro.
We are no longer talking about a default or a bailout here or there. We are talking about the breakup of the euro zone.
(Editing by Hugh Lawson)