Italy's borrowing costs soared at a closely-watched bond auction on Thursday as investors worried by the euro zone debt crisis and an impasse over the U.S. debt ceiling exacted a high risk premium.
The 8 billion euro auction came in volatile markets made more feverish by rumors, denied by a cabinet colleague, that Economy Minister Giulio Tremonti was preparing to resign, and unconfirmed talk of European Central Bank bond-buying.
Pressure on Italian stocks and bonds reflects both concerns about Rome's ability to bring down its debt pile -- second only to Greece's in Europe at 120 percent of annual output -- and wider doubts about whether last week's euro zone summit found a durable solution to the Greek debt crisis.
Concerns about the latest euro zone rescue for Greece have surfaced at the International Monetary Fund, as well as among European economists and market analysts, who say it did too little to reduce Athens' debt mountain.
A Reuters poll of 55 economists showed that a majority felt that while it was a step in the right direction, the rescue package was not a turning point from which the euro zone debt crisis will start to be resolved.
Cyprus may be next in line for a bailout after its cabinet resigned on Thursday over a fatal munitions blast that destroyed the island's power plant and compounded its economic woes, partly due to its exposure to Greek debt.
Italian yields jumped to 5.77 percent on the 10-year bond, the highest since February 2000, and to 4.8 percent on the 3-year bond, the highest since July 2008.
You can argue that they were able to place bonds in the market, but the trend in yields is starting to become really impressive, said Alessandro Giansanti, a strategist at ING in Amsterdam.
They can't afford this kind of increase every month.
DOUBT OVER ECB
The ECB declined comment on rumours among traders that it bought Spanish and Italian bonds ahead of the auction in what would have been its first intervention to try to steady markets since March.
There were some rumours that the ECB is buying Italian and Spanish debt. When you see such a big move before an auction, people seem to jump to that conclusion, one trader said, speaking on condition of anonymity.
However, similar rumours in the run-up to the euro zone summit proved unfounded and regular ECB counterparties said they saw no sign of central bank bond-buying.
Shares in leading Italian banks Unicredit and Intesa Sanpaolo, which had reversed early losses and headed sharply higher on rumours of the ECB intervention, fell back again after the auction.
Market valuations of euro zone bank shares have fallen this year close to levels hit during the global credit crisis of 2008-2009, in terms of both book value and projected earnings for the next 12 months, Thomson Reuters data shows. [graphic: http://r.reuters.com/ruf62s >
Tremonti, long seen as the guarantor of fiscal prudence in Prime Minister Silvio Berlusconi's fractious government, is under pressure over his use of a Rome apartment belonging to an aide under investigation for alleged corruption.
Agriculture Minister Saverio Romano told reporters a rumor that Tremonti was preparing to resign had not been discussed at a cabinet meeting and seems to me absolutely unfounded.
The ECB has bought a total of 74 billion euros in euro zone government bonds since it launched the controversial Securities Markets Program in May 2010 after the 17-nation currency area established a rescue fund to bail out member states shut out of capital markets.
But the program, criticized by former German Bundesbank chief Axel Weber as potentially inflationary, has been largely dormant since January and the ECB has been seeking to exit the bond market and make euro zone governments take responsibility.
Euro zone leaders agreed last week that their bailout fund, the European Financial Stability Facility, would in future be empowered to buy bonds in the secondary market and give states in difficulty precautionary credit lines.
But that will only take effect once new EFSF rules have been approved by national parliaments, which euro zone sources say should happen before the end of the year.
An IMF source said there were growing concerns among non-European members of the global lender's board about the Fund's exposure to Greece and the euro zone.
There is a feeling on the board that we are in the same boat as the Europeans but we don't have much power to take decisions... we are linked to the errors of the Europeans, said the source, who spoke on condition of anonymity because of the sensitivity of the matter.
The issue today is not so much the mistakes of Greece but what is happening with the Europeans. Some people are getting more uncomfortable than before, he said.
The Financial Times quoted the Brazilian and Indian members of the IMF board as warning against pouring further large sums into another Greek bailout with uncertain prospects.
Brazilian director Paulo Nogueira Batista was quoted as saying the austerity imposed on Greece was too tough while Athens' private creditors were given too easy a time.
Greek Finance Minister Evangelos Venizelos appeared to backtrack on Thursday on plans to sell the government's stake in gaming monopoly OPAP (Additional reporting by Harry Papachristou in Athens, Daniel Flynn in Paris, Andy Bruce and William James in London and Jan Strupczewski in Brussels; writing by Paul Taylor; editing by Janet McBride)
(Additional reporting by Harry Papachristou in Athens, Daniel Flynn in Paris, Andy Bruce and William James in London and Jan Strupczewski in Brussels; writing by Paul Taylor; editing by Janet McBride)