France and Germany, Europe's two central powers, clashed on Wednesday over whether the European Central Bank should intervene more forcefully to halt the euro zone's accelerating debt crisis after modest bond purchases failed to stop the rout.
Facing rising borrowing costs as its 'AAA' credit rating comes under threat, France appeared to plead for stronger ECB action, adding to mounting global pressure spelled out by U.S. President Barack Obama.
Bond market contagion is spreading across Europe. Italian 10-year bond yields have risen above 7 percent, unaffordable in the long term. Yields on bonds issued by France, the Netherlands and Austria -- which along with Germany form the core of the euro zone -- have also climbed.
The ECB's role is to ensure the stability of the euro, but also the financial stability of Europe. We trust that the ECB will take the necessary measures to ensure financial stability in Europe, government spokeswoman Valerie Pecresse said after a cabinet meeting in Paris.
Pecresse said Paris believed the risk premium investors charge to hold French debt rather than safe haven 10-year German Bunds is not justified. That spread hit a euro era peak of 195 basis points on Wednesday.
But German Chancellor Angela Merkel made clear Berlin would resist pressure for the central bank to take a bigger role in resolving the debt crisis, saying European Union rules prohibited such action.
The way we see the treaties, the ECB doesn't have the possibility of solving these problems, she said after talks with visiting Irish Prime Minister Enda Kenny.
The only way to recover markets' confidence was to implement agreed economic reforms and build a closer European political union by changing the EU treaty, Merkel said.
ECB policymakers continue to reject international calls to intervene decisively as Europe's lender of last resort, stressing it is up to governments to resolve the debt crisis through austerity measures and reforms.
Traders said the central bank bought Spanish and Italian bonds on Wednesday, but the respite was short-lived and there was no sign of a change in its policy of limited, stop-go purchases to calm markets temporarily while maintaining pressure on governments.
Wall Street opened lower and European shares slipped as investors doubted the ability of governments in the euro zone to contain the crisis.
Obama, on a visit to Australia, turned up the heat on Europe to act more boldly to extinguish the spreading bushfire.
Until we put in place a concrete plan and structure that sends a clear signal to the markets that Europe is standing behind the euro and will do what it takes, we are going to continue to see the kinds of market turmoil we saw, he said.
Obama said that whilst there had been progress in putting together unity governments in Italy and Greece, Europe still faced a problem of political will.
In Rome, Prime Minister-designate Mario Monti unveiled a government of technocrats, taking the key economy portfolio for himself in a drive to implement long delayed structural economic reforms and austerity measures.
Monti, a former European Commissioner, said he hoped markets would be reassured by his team, which features several academics and Intesa bank Chief Executive Corrado Passera, but no politicians. He will present his austerity programme to the Senate on Thursday.
Officials said the new 16-member government, including three women and announced by Monti at the presidential palace in Rome, would be sworn in at 5 p.m. (4 p.m. British time).
Federico Ghizzoni, chief of Unicredit, said he would ask the ECB to increase access to central bank funds for Italian banks, which have faced growing funding problems since Italy was sucked into the debt crisis in July.
European Commission President Jose Manuel Barroso told the European Parliament the euro zone faced a systemic crisis and fragmenting the European Union was no solution.
In Greece, technocrat Prime Minister Lucas Papademos, a former ECB vice-president, was set to win a big confidence vote in parliament for his interim government despite the refusal of the main conservative leader to sign up to more austerity.
New Democracy party chief Antonis Samaras gave Papademos only arms-length backing, refusing to bow to EU demands for a written commitment to the bailout programme and calling for elections in three months to restore social peace.
With Papademos' national unity coalition already split, rebuilding Greece's shattered finances to avert default will be a daunting task as Europe battles to prevent its debt woes from dragging down the world economy.
Financial markets are sceptical that unelected technocrats will have the political clout to impose unpopular reforms, the two-year-old debt crisis risks engulfing the entire currency bloc and hurting global growth.
And there are growing signs of strain in the money market, the plumbing of the international financial system.
Banks in the euro zone face increasing difficulties in obtaining dollar funding, and while the stresses are nowhere near as acute as they were in the 2008 financial crisis, they have continued to mount despite ECB moves to provide unlimited liquidity to banks.
Markets are clearly expecting a circuit breaker to alleviate pressure on periphery bond yields, said David Scutt, a trader at Arab Bank Australia in Sydney. If no announcement is forthcoming in the days ahead, one suspects that the situation could unravel fairly quickly.
With a Brussels-based think-tank warning that France's economy should be ringing alarm bells, Finance Minister Francois Baroin sought to calm fears about public finances.
We are expecting a slowdown, but not a recession, Baroin told LCI news channel. We are doing everything to maintain our credit rating, to borrow more cheaply.
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.
Many analysts believe the only way to stem the contagion for now is for the ECB to buy large amounts of bonds -- effectively the sort of quantitative easing undertaken by the U.S. and British central banks.
The ECB has bought 187 billion euros (160.4 billion pounds) in government bonds since May 2010 but it has so far sterilised all purchases by taking the equivalent amount in from the market in deposits. One option would be to stop fully sterilising bond purchases.
This has been anathema in Germany, which fears that printing money could stoke inflation.
But on Tuesday Peter Bofinger, a member of the group of economists that advises the German government, said the ECB should indeed become the euro zone's lender of last resort if the bloc's debt woes risked tearing apart the financial system.
If politics can't do it, then the ECB must do all it can to bring interest rates down to more reasonable levels, Bofinger said at Euro Finance Week.
(Additional reporting by Emelia Sithole-Matarise in London, Gareth Jones and Dina Kyriakidou in Athens, Deepa Babington in Rome; writing by Paul Taylor; editing by Janet McBride/Mike Peacock.)