Italy's borrowing costs hit a euro lifetime high of nearly 8 percent on Tuesday, taking the debt crisis to a new level of intensity hours before new prime minister Mario Monti was to meet euro zone finance ministers to set out his economic reform plans.

Two years into Europe's sovereign debt crisis, investors are fleeing the euro zone bond market, European banks are dumping government debt, deposits are draining from south European banks and a looming recession is aggravating the pain, fuelling doubts about the survival of the single currency.

Italy had to offer a record 7.89 percent yield to sell 3-year bonds, a stunning leap from the 4.93 percent it paid in late October, and 7.56 percent for 10-year bonds, compared with 6.06 percent at that time.

The yields were above levels at which Greece, Ireland and Portugal applied for international bailouts, but European stocks and bonds rallied in apparent relief at the strong demand, with the maximum 7.5 billion euros sold.

In an ideal world, these yields ... would serve to give the Ecofin/Eurogroup a sense of added urgency, but this is a far from ideal world, said Peter Chatwell, rate strategist at Credit Agricole in London.

Monti was to outline his fiscal and economic reform plans to the 17-nation currency area later on Tuesday amid reports, officially denied in Rome and Washington, of a possible impending approach to the IMF.

The euro and European markets had earlier dipped on a report in business daily La Tribune that ratings agency Standard & Poor's would lower its outlook on France's AAA credit rating to negative within 10 days, dealing a potential body blow to the euro zone's ability to rescue heavily indebted countries.

The European Central Bank failed for the first time since May to fully offset 203.5 billion euros in euro zone government bond purchases. A Reuters poll of economists showed a 40 percent chance of the ECB stepping up bond-buying with freshly created money within six months.

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 December 8 meeting.

Italy has a 1.9 trillion euro debt pile - 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. It has promised to balance its budget in 2013 but Tuesday's auction suggested it will struggle to keep borrowing costs under control without international help.

Italian daily La Repubblica said EU Economic and Monetary Affairs Commissioner Olli Rehn would tell euro zone ministers that Italy needs to introduce extra fiscal measures worth 11 billion euros immediately to meet its target.

In Brussels, Eurogroup ministers were expected to approve detailed plans to bolster their bailout fund to help prevent contagion in bond markets, under pressure from the United States and ratings agencies to stop the crisis spreading.

The report about France's credit rating came at a delicate time. Paris is the second largest guarantor of the EFSF bailout fund, and one of only six AAA states in the euro zone. S&P declined comment. French Finance Minister Francois Baroin, asked about the report, said the focus should not be solely on France.

The euro zone ministers are also set to release a long-delayed 8 billion euro loan installment for Greece, vital to stave off bankruptcy in December and buy time for negotiations on an uncertain second bailout program for Athens.

OBAMA PRESSES

Underlining the threat to tottering European economies, ratings agency Moody's warned it may downgrade the subordinated debt of 87 banks across 15 countries due to concerns that their governments would be too cash-strapped to bail them out.

The greatest number of ratings to be reviewed were in Spain, Italy, Austria and France, Moody's said.

U.S. President Barack Obama pressed European Union officials on Monday to act quickly and decisively to resolve their sovereign debt crisis, which the White House said was weighing on the American economy.

Poland's Foreign Minister Radoslaw Sikorski made an appeal for Germany to show more leadership in the crisis.

You know full well that nobody else can do it, he said in a speech in Berlin on Monday evening, referring to efforts to save Europe's monetary union.

I will probably be the first Polish foreign minister in history to say so, but here it is: I fear German power less than I am beginning to fear German inactivity. You have become Europe's indispensable nation.

Eurogroup ministers were set to agree details of leveraging the European Financial Stability Fund (EFSF) so it can help Italy or Spain should they need aid, although worsening market conditions mean it may miss the original 1 trillion euro target.

Documents obtained by Reuters on Sunday showed the detailed guidelines for the EFSF were ready for approval, opening the way for new operations and multiplying the fund's effective size.

The documents spell out rules for EFSF intervention on the primary and secondary bond markets, for extending precautionary credit lines to governments, leveraging its firepower and its investment and funding strategies.

The EFSF guidelines will clear the way for the 440 billion euro facility to attract cash from private and public investors to its co-investment funds in coming weeks.

The ECB, which is now buying bonds of Spain and Italy on the market to prevent their borrowing costs running out of control, has urged ministers to finalize the technical work quickly.

Officials said the leveraging mechanisms could become operational in January, but that may be too late.

With Germany opposed to the idea of the ECB 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.

It bought 8.5 billion euros of euro-zone government debt in the latest week, at a time of acute turmoil, in line with its previous activity but well short of what economists say is necessary to turn market sentiment around.

One option EU sources said is being is explored is for euro system central banks to lend to the IMF to aid Italy and Spain.

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 an EU summit on December 9 that is increasingly seen by investors as possibly the last chance to avert a breakdown of the single currency area.

(Additional reporting by Marius Zaharia in London, Erik Kirschbaum in Berlin, Cecile Lefort in Sydney; Writing by Paul Taylor; editing by Janet McBride)