Pressure eased on Europe's government debt market Wednesday, with Italian borrowing costs back below the 7 percent level viewed as unsustainable after the European Central Bank was seen buying up bonds.

Equity markets were generally lower, although European shares firmed <.FTEU3>, and the euro itself hit a one-month low against both the dollar and the Japanese yen.

Italian 10-year bond yields were at 6.85 percent, having peaked well above 7 percent on Tuesday, the level generally viewed as requiring an outside bailout.

Traders said the ECB was behind the move. They're heavily in on Italy and Spain, 2-10 years, one bond trader said.

Contagion from the weakest debt-ridden euro zone economies such as Greece into bigger ones such as Italy, Spain and even France is now the dominant fear for global investors.

It is no pandemic yet, but yields have been rising sharply almost across the board, with France now firmly in the firing line, suggesting the steps taken by policymakers and governments to contain the debt crisis have been nowhere near enough.

Investors question the ability of debt-ridden euro zone countries such as Italy to do what it takes to reverse their economic decline and the long-term willingness of the European Central Bank to act forcefully enough to end the crisis.

Up to now, it has bought bonds intermittently and only in sufficient size to stem sharp sell-offs.

They (the ECB) don't seem to want to use the ammunition that's required to stop this at the moment, another bond trader said, asking not to be named.

Attention is turning to France, one of the core euro zone countries, but with a large debt to GDP ratio. Yields on French 10-year bonds are at 3.62 percent, having traded around 2.5 percent only two months ago.

If it succumbed, the entire euro project would be in peril.

French yields are way below crisis levels but still around 2 percentage points higher than German equivalents, a euro era record.

We now have to ask ourselves: what if a state goes bankrupt? What if a state gets out of the euro zone? said Bertrand Lamielle, head of asset management at Paris-based B*Capital.

WEAKER EURO

World shares were generally lower with the MSCI all-country world index <.MIWD00000PUS> off a quarter of a percent.

European shares managed to put in modest gains, however, after opening lower. The FTSEurofirst 300 <.FTEU3> was up 0.6 percent.

This market is not about macro or micro data, it's all about sovereign bond yields. The apostles of the value style have been saying for 18 months: 'stocks are cheap'. They look cheap indeed, but the focus is elsewhere, Lamielle said.

The macroeconomic picture, framed by the debt crisis, is not robust. Data on Tuesday showed the economy of the 17-nation euro zone barely grew in the third quarter. ECB President Mario Draghi has predicted the currency bloc will be in a mild recession by the end of the year.

The euro slipped to a fresh one-month low against the dollar and the yen.

The common currency fell as far as $1.3437, its lowest level in more than a month, after the French bond yield spread over benchmark German bunds hit its euro-era high.

It was later flat on the day at $1.353.

While it is clear that the data in the U.S. is improving, European concerns far outweigh at present, said David Scutt, a trader at Arab Bank Australia in Sydney.

Markets are clearly expecting a circuit breaker to alleviate pressure on periphery bond yields. If no announcement is forthcoming in the days ahead, one suspects that the situation could unravel fairly quickly.

(Additional reporting by Emelia Sithole-Matarise and Blaise Robinson; editing by Mike Peacock)