Yields on German government bonds, normally seen as a safe haven by investors, rose on Wednesday as deepening uncertainty over how to stem the euro zone's debt crisis hit even Europe's strongest economy.

The yield on the 10-year German Bund, the benchmark for all euro zone debt, topped 3 percent for the first time in seven months, partly due to a sell-off in U.S. Treasuries but also due to anxiety over policy differences within the European Union.

Germany and France are pushing for an EU summit next week to approve a proposed treaty change that would allow debt-stricken euro zone states to make an orderly default, with private sector bondholders sharing losses on a case-by-case basis.

But euro zone finance ministers did not agree on any new action this week to stem the crisis, fuelling bond market doubts about whether the bloc can find a formula to halt contagion in the 16-nation single currency area.

The Bund yield has shot up from 2.4 percent in early November, while the borrowing costs of weaker euro zone economies -- Greece, Ireland, Portugal, Spain and Italy -- have also surged due to market jitters over default risks.

In the absence of a rise in inflationary expectations, this increase is due entirely to market uncertainties over Germany's own exposures to save the eurozone, and the size of fiscal transfers needed, the Eurointelligence financial website said.

A sale of 4 billion euros of two-year German bonds found poor demand on Wednesday, drawing total bids worth less than the amount on offer, amid wider uncertainty about the euro zone.

Peter Chatwell, rate strategist at Credit Agricole in London, said bond markets were suffering huge volatility in thin liquidity at the moment.


Two euro zone countries -- Greece and Ireland -- have had to seek IMF/EU rescue packages tied to strict austerity conditions after being effectively shut out of capital markets. Many analysts expect Portugal to need a bailout soon and some believe Spain will also need assistance, although both governments insist they do not require aid.

The European Commission on Wednesday welcomed Ireland's tough 2011 austerity budget, which received a first approval from parliament late on Tuesday, opening the way for international loans to start flowing to Dublin.

It is a successful first step toward the implementation of the program that was agreed with the EU and the IMF, Commission spokesman Amadeu Altafaj said in Brussels.

International Monetary Fund chief Dominique Strauss-Kahn criticized Europe's slow, piecemeal response to the debt crisis on Tuesday and called for a comprehensive solution.

German Chancellor Angela Merkel has rejected the two most widely discussed proposals for surmounting the crisis -- increasing the size of the euro zone's financial safety net or issuing joint bonds to reduce weaker states' borrowing costs.

A German government spokesman said there were economic and legal hurdles to introducing such 'E-bonds', which would not be possible without fundamental changes to the EU's Lisbon Treaty. Berlin was still against the idea.

The chairman of euro zone finance ministers, Jean-Claude Juncker, accused Berlin of spurning the bond proposal without examining it properly. Juncker put forward the suggestion this week with Italian Economy Minister Giulio Tremonti.

The proposal is being rejected before it has been studied, Juncker was quoted as saying in an interview with the newspaper Die Zeit. Germany's thinking is a bit simple on that.

Juncker said he was not proposing a single interest rate to bundle all national debt on a European level, and a large part of the debt would remain at national rates.

Some European Central Bank policymakers, while urging euro zone governments to toughen up budget rules and take stronger deficit-cutting measures, have advocated increasing the bloc's rescue fund and voiced interest in the idea of common bonds.

ECB governing council member Erkki Liikanen said on Wednesday the euro zone was still in a very fragile situation. High debt levels and weak competitiveness have sapped the markets' confidence in many countries' ability to service their debts, he said.

When reforming the governance of economic policies, it is important that the EU and its member states are suitably ambitious, Liikanen added.

(Additional reporting by William James in London, Marcin Grajewski in Brussels, Paul Carrel and Annike Breidthardt in Berlin, Terhi Kinnunen in Helsinki; writing by Paul Taylor, editing by Mark Trevelyan)