Asian shares and the euro fell on Wednesday as signs that rising borrowing costs were affecting AAA-rated France stirred fears that even core euro zone members may not escape contagion from the region's debt crisis.
The political outlook remained unclear in struggling Italy and Greece as they attempt to push through severe austerity measures needed to get bail-out funds and win market confidence. Prime Minister designate Mario Monti was expected to unveil Italy's new government on Wednesday.
MSCI's broadest index of Asia Pacific shares outside Japan <.MIAPJ0000PUS> fell 2.1 percent, while Japan's Nikkei stock average <.N225> slipped 0.9 percent on Wednesday. <.T>
The euro hit a five-week low against both the dollar and the yen, as euro zone jitters spurred risk aversion, and stood down 0.7 percent at $1.3437. Gold fell 1 percent to $1,763.39 an ounce as some sought to cover losses in riskier assets.
Markets are clearly expecting a circuit breaker to alleviate pressure on periphery bond yields, said David Scutt, a trader at Arab Bank Australia in Sydney. If no announcement is forthcoming in the days ahead, one suspects that situation could unravel fairly quickly.
European stocks were set to fall, with spreadbetters seeing London's FTSE 100 <.FTSE> opening down 0.6 percent, Frankfurt's DAX <.GDAXI> down 0.9 percent, and Paris' CAC-40 <.FCHI> 0.6 percent lower. <.EU> <.L>
Italian 10-year bond yields on Tuesday climbed back above 7 percent, a level of funding costs seen as unsustainable for the debt-ridden country, while Spanish 10-year bond yields rose to 6.3 percent.
The trend spread to France, where the premium over comparable German Bunds hit euro-era highs above 190 basis points. French banks are among the most exposed to Italy's 1.8 trillion euro ($2.4 trillion) public debt, holding $416 billion as of end-June, Bank for International Settlements data showed. Italian debts' premium over Bunds rose above 500 basis points.
Italy's five-year credit default swaps (CDS) -- a form of insurance against default -- scaled a new high of 600 basis points, with Italian banks and corporates the worst performers in the Markit iTraxx Europe CDS index on Tuesday.
Bearish sentiment spilled over to Asian credit markets, with risk aversion pushing the spreads on the iTraxx Asia ex-Japan investment grade index wider by 6 basis points.
ECB ROLE EYED
The uncertainty over fiscal reforms in highly indebted euro zone countries has sparked heavy selling of bonds issued by these countries, prompting financial institutions to slash their bond holdings for fear of posting huge losses as prices plunged.
Pressures for banks to beef up their capital base have only exacerbated the situation as banks' accelerated deleveraging has further eroded their appetite for government debt.
Borrowing difficulties have fueled concerns about fund raising in general, increasing strains in money markets.
Euro/dollar three-month cross currency basis swaps widened to -128.0 basis points at one point on Tuesday, the most since late 2008.
This indicates funding issues, the market getting very nervous, said a trader for a European bank in Singapore.
With an absence of government debt buyers threatening to squeeze liquidity, the ECB has no choice but to provide whatever liquidity the system needs and remain a very active part of the European financial market, said Adrian Foster, head of financial markets research for Asia-Pacific at Rabobank International in Hong Kong.
Many analysts say the ECB could stem this negative spiral by buying large amounts of bonds, under similar quantitative easing measures implemented by the U.S. and British central banks.
But Germany is resolutely opposed to such moves and the ECB has repeatedly rebuffed calls to become the lender of the last resort, saying it is up to individual governments to put their fiscal houses in order.
As policymakers stand at odds in determining details of the roadmap to resolve the debt crisis, EU governments have until a summit on December 9 to offer a bolder and more convincing strategy, including visible financial backing.
The sovereign debt problems have slashed euro zone growth to a mere 0.2 percent in the third quarter, raising the risk of a recession.
The United States, however, where economists expect gross domestic product growth of 1.8 percent this year, has seen recent data suggesting its economy was likely to stay clear of a recession, with October retail sales beating forecasts.
In the current environment, a 1-1/2 to 2 percent growth would be seen as a positive support for the market, Rabobank's Foster said. ($1 = 0.739 Euros)
(Additional reporting by Ian Chua in Sydney and Masayuki Kitano in Singapore; Editing by Alex Richardson)