The euro zone's debt crisis struck again at the heart of Europe on Monday despite a clear-cut election victory in Spain for conservatives committed to tougher austerity.
Spain's Socialists became the fifth government in the 17-nation single currency area to be toppled by the debt crisis this year. Portugal, Ireland, Italy and Greece went before.
But an absolute parliamentary majority for Mariano Rajoy's centre-right Popular Party brought no respite on financial markets increasingly alarmed by the absence of an effective firewall to halt a meltdown on sovereign bond markets.
The risk premiums on Spanish, Italian and French government bonds rose as investors fled to safe-haven German Bunds, while European shares fell more than 2 percent after Moody's warned that France's credit rating faces new dangers.
This crisis is hitting the core of the euro zone. We should have no illusions about this, European Economic and Monetary Affairs Commissioner Olli Rehn said.
He defended the European Union executive's advocacy of austerity policies blamed for choking off growth and jobs.
One simply cannot build a growth strategy on accumulating more debt, when the capacity to service the current debt is questioned by the markets, Rehn told a Brussels seminar. One cannot force foreign creditors to lend more money, if they don't have the confidence to do it.
In Greece, the starting point of market turmoil now felt around the world, more political wrangling cast a pall over the new technocrat prime minister's bid to win the nod from European leaders on Monday for bailout funds.
Borrowing costs for both Spain and Italy hit levels regarded as unsustainable last week before the European Central Bank stepped in to stabilise the market.
Two newspapers said the ECB's governing council had imposed a weekly limit of 20 billion euros on purchases of euro zone government bonds, a figure analysts say prevents it acting as an effective firebreak.
FRENCH RATING RISK
Ratings agency Moody's said a recent rise in interest rates on French government debt and weaker economic growth prospects could be negative for France's credit rating.
Elevated borrowing costs persisting for an extended period would amplify the fiscal challenges the French government faces amid a deteriorating growth outlook, with negative credit implications, Senior Credit Officer Alexander Kockerbeck said in Moody's Weekly Credit Outlook dated November 21.
France's government spokeswoman reaffirmed on Monday that Paris would not impose a third package of budget savings, despite market pressure on its cost of credit.
Talk of a possible break-up of the 12-year-old single currency has grown among economists and market analysts, mostly outside the euro area, as EU paymaster Germany has rejected most of the widely-touted solutions to the debt crisis.
The chairman of Goldman Sachs Asset Management, Jim O'Neill, said the crisis of European economic and monetary union (EMU) had reached a point where big decisions have to be taken pretty quickly.
It's not obvious to me that EMU could survive without Italy, he told a Confederation of British Industry conference.
It's not obvious to me that Italy can survive with 6-7 percent bond yields, so something's going to have give pretty quickly. Italian bond yields have got to come down pretty quickly or EMU will have some severe challenges.
Dutch Finance Minister Jan Kees de Jager, one of Berlin's closest allies, acknowledged that the euro zone could splinter.
Asked whether a break-up of the euro would cause an economic depression, he told BNR radio: This could be a consequence from the euro zone falling apart, that is correct.
You never know it for sure but it is a likely outcome if the euro zone falls apart. Therefore all our efforts are to prevent that scenario, De Jager said.
Spaniards gave the People's Party a clear mandate for more austerity against a background of 21 percent unemployment and one of the highest budget shortfalls in the region.
We will stop being part of the problem and will be part of the solution, party leader Mariano Rajoy said after the vote.
Analysts said they expected Rajoy, who will not be sworn in until December, to move quickly to turn the economy around.
This could calm markets but until the new government does what it says it is going to do, nothing will change, said Angel Laborda, analyst at Madrid think-tank Funcas.
Nicolas Lopez, head of research at M&G Valores, said the government had to introduce convincing measures. While these measures are being taken, the ECB will have to buy up bonds as it has been doing to maintain confidence, he said.
In Italy, newly-installed Prime Minister Mario Monti, who easily won confidence votes in both houses of parliament last week, could face a battle to win backing for greater austerity or liberalisation than Silvio Berlusconi was able to achieve.
Italian newspapers said on Sunday that new budget measures were likely to be unveiled within two weeks, with a property tax abolished by Berlusconi set to return, plus moves to tackle tax evasion and a cut in payroll taxes to lift employment.
Greek Prime Minister Lucas Papademos will meet EU Commission President Jose Manuel Barroso and Eurogroup head Jean-Claude Juncker on Monday after EU, IMF and European Central Bank representatives held tough talks in Athens.
Fearful of alienating voters, Antonis Samaris, head of the conservative New Democracy party, refused to give a written commitment to the terms of a second bailout programme, no matter who wins an election expected on February 19.
The leader of the far-right LAOS party said international lenders would not release the 8 billion dollars Greece needs to avoid default in mid-December without the guarantee.
Euro zone wide planning to improve the region's economic governance and restore market faith in the single currency is also mired in disagreements.
Details of how the European Financial Stability Facility (EFSF), the bloc's rescue fund, will act as a bond insurer and attract foreign investors are still undecided and the ECB says it will not act as a lender of last resort.
The European Commission will propose much tighter control of budgets on Wednesday along with three options for joint debt issuance of the 17 countries sharing the euro, but without any conclusions or suggestions of which one to chose.
(Additional reporting by Gilbert Kreijger in Amsterdam, Fiona Sheikh in London, Lefteris Papadimas in Athens, Crispian Balmer in Rome and Jan Strupczewski in Brussels; Writing by Paul Taylor; Editing by)