Financial markets held their breath on Tuesday as Italian Prime Minister Silvio Berlusconi's reform-shy government teetered on the brink and debt-crippled Greece's leaders struggled to put together a national unity government.

Berlusconi's closest coalition ally, Umberto Bossi, head of the populist Northern League, told the 75-year-old billionaire media magnate to resign in what could be a mortal blow. But Berlusconi clung to office before a crunch vote in parliament.

We asked the prime minister to stand down, Bossi told reporters, saying he should make way for Angelino Alfano, secretary of the premier's PDL party.

Italy has displaced Greece as the epicentre of the euro zone's sovereign debt crisis, with government bond yields nearing unsustainable levels that could force the bloc's third largest economy to seek a bailout that Europe cannot afford.

Italian 10-year borrowing costs touched a new record of 6.71 percent on Tuesday, raising the risk that Rome's massive debt -- the second highest in Europe at 120 percent of gross domestic product -- could spiral out of control.

Now we are really reaching very dangerous levels ... We are above yield levels in the 10-year where Portugal and Greece and Ireland issued their last bonds, said Alessandro Giansanti, a rate strategist at ING.

Five PDL lawmakers said they would abstain in the vote on public finances, due at 1600 GMT, putting Berlusconi's majority in danger. The main opposition parties said they would also abstain, allowing last year's budget to be approved while highlighting the government's weakness.

Even if he survives on Tuesday, the prime minister, battered by a series of trials and sex scandals, may face a tough confidence vote later this week.

Euro zone finance ministers, meeting in Brussels, agreed on Monday on a roadmap for boosting the 17-nation currency bloc's 440-billion-euro (372-billion-pound) rescue fund to shield larger economies like Italy and Spain from a possible Greek default.

But with bond investors increasingly on strike, there are doubts about the efficacy of those complex leveraging plans.

Countries outside the euro area kept up a chorus of pressure for more decisive action to stop the crisis spreading.

The euro zone needs to show the world it can stand behind its currency, it cannot just wait on developments in Athens and in Rome, Chancellor George Osborne said.

Swedish Finance Minister Anders Borg added: Europe is running dry on credibility and a solution to a high debt crisis must be lower debt. The responsibility for that falls with the country with high debt and that is obviously Greece and Italy.

DISTRESS SIGNALS

Distress signals from the bond market and the European Central Bank showed the crisis is gathering pace alarmingly.

Shifts in the Italian yield curve and a widening gap between the prices bondholders demand for Italian debt and what potential buyers are prepared to pay are flashing warning signs similar to those seen in Portugal, Greece and Ireland before high borrowing costs froze them out of debt markets.

In a sign that they are increasingly cut out of money markets, the ECB reported Italian banks needed 111.3 billion euros in central bank funding in October, up from 104.7 billion euros in September and a mere 41.3 billion in June.

Even the European Financial Stability Facility, the euro zone's bailout fund, had difficulty finding buyers for its top-notch AAA-rated paper on Monday, drawing barely enough bids for 3 billion euros of 10-year bonds issued to support Ireland.

EFSF head Klaus Regling cited a very difficult market climate and uncertainty about the fund's future profile as factors in the weak demand.

Finnish Prime Minister Jyrki Katainen, facing growing hostility in his country to bailouts for euro zone weaklings, said Italy was to big to be rescued.

It is difficult to see that we in Europe would have resources to take a country of the size of Italy into bailout programmes, he told parliament.

In Athens, wrangling continued to try to form an interim administration to save Greece from bankruptcy by enacting a second international bailout plan before early elections, after Socialist Prime Minister George Papandreou agreed to step down.

Early signs that a deal was within reach on a 100-day government to push the 130 billion euro bailout, including a voluntary 50 percent writedown on Greece's debt to private sector bondholders, through parliament by February appeared to be fading over the choice of prime minister.

Former ECB vice-president Lucas Papademos was in talks with ruling Socialist and conservative opposition leaders on heading the government, but one sticking point was whether members of the main opposition New Democracy party would join the cabinet.

In Brussels, the 27 European Union finance ministers were debating how to strengthen Europe's shaky banks to cope with the sovereign debt shock without halting lending to the real economy.

Options on the table included offering state guarantees to borrower banks or injecting cash into the European Investment Bank, the EU's project finance arm, so that it can lend them more.

A bank recapitalisation agreed at last month's EU summit will cost about 100 billion euros, the European Banking Authority (EBA) said, and some countries wanted a more flexible definition of capital to reduce the overall cost.

(Additional reporting by Emilia Sithole-Matarise in London, Paolo Biondi in Rome, Sarah Marsh in Berlin, Valentina Za in Milan, John O'Donnell and Jan Strupczewski in Brussels, Jussi Rosendahl in Helsinki; Writing by Paul Taylor, editing by Mike Peacock)