Italy overtook Greece as the prime threat to the stability of the euro zone on Monday as governments sought to placate frantic bond markets and halt accelerating financial contagion.

Italian government bond yields rose to their highest since 1997 -- approaching levels regarded as unsustainable -- as political turmoil in Rome threatened to drag the euro zone's third largest economy deeper into the region's debt crisis.

Greece's outgoing socialist prime minister and conservative opposition leader rushed to put in place an interim national unity government for just long enough to save the country from imminent default by implementing a new bailout programme.

France announced a new wave of austerity measures designed to preserve its wobbly AAA credit rating, without which the euro zone might no longer be able to bail out its weakest members.

In Brussels, euro zone finance ministers agreed a detailed mandate to scale up the currency zone's rescue fund by the end of November to shield vulnerable but solvent economies such as Italy's and Spain's from a possible Greek default.

In Italy, Prime Minister Silvio Berlusconi defied huge pressure to resign as he struggled to hold a crumbling centre-right coalition together after being forced to accept intrusive IMF surveillance of his economic reforms.

Political sources said leaders of Berlusconi's PDL party had urged him to resign late on Sunday but he was resisting.

Stocks fell worldwide on the uncertainty, but Italian shares ended higher, partly on hopes that Berlusconi could soon be gone, traders said.

A cabinet minister said Italy would face early elections if party rebels stripped Berlusconi of his majority in a crunch vote on public finances in parliament on Tuesday.

If we have the majority we'll carry on, otherwise there'll be elections, Gianfranco Rotondi, a minister without portfolio, said after meeting Berlusconi at his Milan home.

Former European Central Bank vice-president Lucas Papademos was on his way to Athens, tipped to head a transitional Greek cabinet charged with pushing a 130 billion-euro ($170 billion) bailout plan through parliament to secure a crucial 8 billion-euro aid tranche before early general elections in February.

But the European Union's ombudsman, Nikiforos Diamandouros, told Reuters he too had been approached on Sunday as a possible candidate to lead the government and did not rule it out. A Greek government spokesman said talks on finding a new prime minister were continuing in a good spirit, indicating no decision had been reached.

The chairman of euro zone finance ministers, Jean-Claude Juncker, said they aimed to conclude a second bailout programme with the new government by the end of the year.

A senior opposition source said Finance Minister Evangelos Venizelos and his top economic team would stay for continuity.

Whoever leads the temporary Greek administration will face a monumental task in restoring order to a country of 11 million whose chaotic economy and politics are shaking international confidence in the entire euro project.


In Paris, President Nicolas Sarkozy's centre-right government announced a new wave of austerity measures, bringing forward a rise in the retirement age, raising some taxes and de-coupling welfare benefits from inflation, in a drive to cling on to France's top-notch credit rating.

The package designed to save 18.6 billion euros in 2012 and 2013 inflicted further pain on voters six months before Sarkozy is expected to seek re-election against a resurgent Socialist opposition, whose candidate, Francois Hollande, is far ahead of him in opinion polls.

Prime Minister Francois Fillon said French public finances had been in the red for 30 years and the time had come to break with the damaging habit of spending beyond its means.

We've got to pull out of this dangerous spiral, he told a news conference.

As finance ministers of the 17-nation currency area conferred on Greece and ways of strengthening their financial firewall, one euro zone official said: We exhausted our scope for concern with Greece. The main concern of the ministers now is Italy and the leveraging of the EFSF.

Euro zone leaders agreed last month to scale up the European Financial Stability Facility's firepower to around 1 trillion euros by offering first loss guarantees on new bond issues, and attracting foreign investors through a special purpose vehicle with credit enhancements.

Europe's top economic official, Olli Rehn, said that while the European Commission had to be ready for all eventualities, there was no study being conducted of how a country could leave the euro zone, which is not foreseen in the EU treaty.

We want to ensure that Greece can and will stay in the euro, he told the European Parliament.

Until the new firefighting tools are ready, the task of trying to prevent a bond market meltdown that could leave bigger euro zone economies needing rescuing falls to the European Central Bank.

The ECB disclosed on Monday that it had stepped up purchases of euro zone government bonds, presumed to be mostly Italian, buying 9 billion euros last week in the first few days in office of new ECB President Mario Draghi.

But the bond-buying, which prompted the two most senior German ECB policymakers to resign this year, failed to stop Italian spreads over safe-haven German Bunds hitting a euro lifetime high due to the deepening political instability.


Another row between the guardians of German central bank orthodoxy and euro zone financial firefighters burst into the open when the German government was forced to deny reports that it had sought to tap the Bundesbank's gold reserves.

Several G20 sources said leaders of the world's major economies had discussed at a summit in Cannes last week the possibility of euro zone countries pooling their borrowing rights at the International Monetary Fund to provide greater leverage for the EFSF. The Bundesbank holds Germany's Special Drawing Rights, secured by its gold reserves.

German sources said the proposal had caused tension between Bundesbank President Jens Weidmann and Finance Minister Schaeuble, as well as between Weidmann and the ECB.

German gold reserves must remain untouchable, Economy Minister Philipp Roesler said when asked about the issue. The Bundesbank and a spokesman for Chancellor Angela Merkel also ruled out the idea.

The European Union did receive one boost on Monday to its efforts to limit the fallout from the debt crisis by countering a risk of bank credit to the real economy drying up.

The European Investment Bank, the EU's soft lending project finance arm, told ministers it could provide up to 74 billion euros of lending support to beleaguered European banks over two years if its capital base was reinforced in part with cash from its shareholders, which are the 27 EU governments.

The risk of the banks de-leveraging is not negligible and the EIB lending to the real economy through banks is thus important to maintain and even increase, an EIB paper seen by Reuters said.

EU banks have to raise a total of 109 billion euros of additional capital by the end of June under a recapitalisation plan agreed by the bloc's leaders last month.

(Additional reporting by Ana Nicolaci da Costa in London, Gavin Jones and Barry Moody in Rome, Brian Love and Vicky Buffery in Paris, Jan Strupczewski, Ilona Wissenbach and John O'Donnell in Brussels, Harry Papachristou and Ingrid Melander in Athens, Ritsuko Ando and Terhi Kinnunen in Tampere; writing by Paul Taylor; editing by Andrew Roche)