Euro zone ministers agreed to ramp up the firepower of their rescue fund, but couldn't say by how much, and may turn to the IMF for more help as a stunning leap in Italy's borrowing costs pushed the region closer to financial disaster.
Two years into Europe's sovereign debt crisis, investors are fleeing the euro zone bond market, European banks are dumping government debt, south European banks are bleeding deposits and a recession looms, fuelling doubts about the survival of the single currency.
The situation in Europe and the world has significantly worsened over the past few weeks. Market stress has intensified, said Christian Noyer, France's central bank governor and a governing council member of the European Central Bank.
We are now looking at a true financial crisis -- that is a broad-based disruption in financial markets, he said at a conference in Singapore on Wednesday.
The Eurogroup, which brings together finance ministers from the 17 euro zone members, agreed on Tuesday to a detailed plan to insure the first 20-30 percent of new bond issues for countries having funding difficulties and to create co-investment funds to attract foreign investors to buy euro zone government bonds.
Both schemes would be operational by January with about 250 billion euros (213 billion pounds) from the euro zone's EFSF bailout fund available to leverage after funding a second rescue programme for Greece, Eurogroup chairman Jean-Claude Juncker said.
The aim was for the International Monetary Fund to match and support the new firepower of the European Financial Stability Facility, Juncker told a news conference.
We also agreed to rapidly explore an increase of the resources of the IMF through bilateral loans, following the mandate from the G20 Cannes summit, so that the IMF could adequately match the new firepower of the EFSF and cooperate even more closely, he said.
But with China and other major sovereign funds cautious about investing more in euro zone debt, EFSF chief Klaus Regling said he did not expect investors to commit major amounts to the leveraging options in the next days or weeks.
He said he couldn't put a figure on the final size of the leveraged fund.
It is really not possible to give one number for leveraging because it is a process. We will not give out a hundred billion next month, we will need money as we go along, he said.
Most analysts agree the euro zone needs to adopt profound measures to combat a crisis that is sucking in some of the bloc's biggest economies.
Italy, the euro zone's third-biggest economy, had to offer a
7.89 percent yield to sell 3-year bonds, a euro lifetime high and a staggering jump from 4.93 percent paid in October. Yields on 10-year debt rose to 7.56 percent from 6.06 percent.
The European Commission's top economic official, Olli Rehn, said Prime Minister Mario Monti's new government would have to take extra deficit cutting measures beyond an austerity plan already adopted to meet its balance budget promise in 2013.
The Italian yields were above the levels at which Greece, Ireland and Portugal were forced to apply for international bailouts. But global stocks and the euro held firm on relief at strong demand for the Italian debt, with the maximum 7.5 billion euros sold.
LOOKING TO IMF
The Eurogroup ministers agreed to release their portion of an 8 billion euro aid payment to Greece, the sixth instalment of 110 billion euros of EU/IMF loans agreed last year and necessary to help Athens stave off the immediate threat of default.
Juncker said the money would be released by mid-December, once the IMF signs off on its portion early next month.
With Regling unable to put a single figure on the scaled up EFSF, which EU leaders had hoped would reach 1 trillion euros, finance ministers said the IMF may have to provide more help, possibly bolstered with European money.
We will have to look at the IMF which can also make available additional funds for the emergency fund. I think countries in Europe and outside of Europe should be prepared to give more money to the IMF, Dutch Finance Minister Jan Kees de Jager told reporters.
We have talked about leverage though private money, but it would be two or two and a half times an increase so not sufficient and we have to look for other solutions to compliment the EFSF and that in my mind will be the IMF, he said.
However, a G20 source said policymakers had made no progress so far in efforts to boost IMF resources, which at current levels may not be sufficient to overcome the crisis. G20 leaders earlier this month promised to boost the agency's warchest.
EU sources said one option being explored is for euro system central banks to lend to the IMF so it can in turn lend to Italy and Spain while applying IMF borrowing conditions.
We will discuss with the ECB. The ECB is an independent institution, so we will put on the table some proposals and after that it is for the ECB to take the decision, Belgian Finance Minister Didier Reynders told reporters.
With Germany opposed to the idea of the European Central Bank providing liquidity to the EFSF or acting as a lender of last resort, the euro zone needs a way of calming markets.
The ECB shows no sign yet of responding to widespread calls to massively increase its bond-buying.
The ECB failed for the first time since May to fully offset 203.5 billion euros in euro zone government bond purchases, adding to fears that the debt crisis is ratcheting up stress on the bloc's banking sector.
A Reuters poll of economists showed a 40 percent chance of the ECB stepping up bond-buying with freshly created money within six months, something it has opposed.
The poll forecast a 60 percent chance of an ECB rate cut to 1.0 percent next week and a big majority of economists said they expect the central bank to announce new long-term liquidity tenders to help keep banks afloat at its next meeting on Dec 8.
Indeed, Noyer said financial conditions in Europe had tightened as a result of the debt crisis and loss of confidence.
There are now more downside risks to price stability, he said.
Monti outlined his fiscal and economic reform plans to the euro zone ministers amid reports, officially denied in Rome and Washington, that Italy has held preliminary discussions with the IMF on financial support.
Italy has debts of 1.9 trillion euros - equivalent to 120 percent of national output - and needs to refinance some 340 billion euros of maturing debt next year with big redemptions starting in late January.
Most analysts say the ECB will have to intervene more decisively on bond markets and the euro zone will have to agree eventually to issue common bonds, but Germany opposes both.
Berlin has pinned its efforts on a drive for closer fiscal integration among euro zone members.
Chancellor Angela Merkel told lawmakers she would not make a deal at a December 9 European Union summit to drop resistance to joint euro zone bonds in exchange for progress on strengthening fiscal rules, MPs quoted her as saying.
She told a closed-door meeting Europe was a long way from euro bonds, suggesting they may not be ruled out forever.
For now, Germany and France are pressing for coercive powers to reject euro zone members' budgets that breach EU rules, alarming some smaller nations who fear the plans by-pass mechanisms for ensuring equal treatment.
Berlin and Paris aim to outline proposals for a fiscal union before the EU summit that is increasingly seen by investors as a last chance to avert a breakdown of the single currency area.
(Additional reporting by Marius Zaharia in London, Erik Kirschbaum in Berlin, Robin Emmott and John O'Donnell in Brussels, Saeed Azhar and Kevin Lim in Singapore; Writing by Paul Taylor/Mike Peacock; Editing by Neil Fullick)