Italy had to pay record interest to sell its bonds on Tuesday as it raced to calm market fears that it was losing control of a huge public debt and could trigger a crisis that threatened the euro zone.
Prime Minister Silvio Berlusconi said a 54 billion euro austerity plan would be approved by parliament on Wednesday and promised to pursue other measures to boost growth. Sources told Reuters the government was also considering sales of property and local utilities to raise funds to cut its debt -- now around 120 percent of annual national output.
Quite simply, investors have lost confidence in Italy's ability to extricate itself from the euro zone debt crisis, said sovereign debt consultancy Spiro Sovereign Strategy.
The implications of this for Europe's monetary union are quite worrying.
Rome has been dependent on the European Central Bank, which has bought its bonds to keep borrowing costs at a manageable level, but a surge in yields over the past week suggests that markets have lost faith in the ECB intervention.
At the auction on Tuesday, the Treasury sold some 6.49 billion euros of long-term bonds -- not far off its maximum target of 7 billion euros -- but was forced to pay 5.6 percent on nearly 4 billion euros of five-year paper.
That yield was the highest since the introduction of the euro more than a decade ago, underlining growing investor concern about the sustainability of a 1.9 trillion euro public debt mountain.
The bid-to-cover ratio, an indicator of investor demand, fell to 1.279, well below the 1.93 on a previous auction of five-year paper.
Amid reports that Rome had also asked China to buy Italian bonds, the euro fell against the dollar after the results, which did nothing to allay concerns that the euro zone's crisis is still deepening.
Markets want to see decisive action and they want to see someone in control of the situation, said Marc Ostwald, a London-based analyst with Monument Securities.
Nothing that we've had, be it at a domestic level in Italy, be it at a pan euro zone level, or above all from Germany, indicates that anyone really is getting to grips with presenting euro zone policy with one voice.
Berlusconi, who has been embroiled in a fresh prostitution scandal, skipped a meeting with magistrates on Tuesday to meet European Union officials in Brussels.
STATE ASSET SALE
The government called a confidence motion for Wednesday in the Chamber of Deputies to hasten approval of the plan to balance the budget in 2013, but the measures announced have failed to convince investors the crisis is under control.
The confidence vote, which would force the government to resign if it lost, follows the same procedure in the Senate last week. The result is expected at around 1200 GMT on Wednesday and definitive approval of the plan is seen at around 1800 GMT (2 p.m. EDT).
In Rome, a senior Treasury official said the government was considering plans to reinforce the package with extra measures including the sale of state assets and expected to meet potential investors as early as next week.
The premium investors demand to buy Italian 10 year bonds rather than safer benchmark German debt rose above 400 basis points ahead of Tuesday's auction but eased slightly in the afternoon, narrowing to 397 points..
Credit default swaps, an insurance-like instrument to hedge against debt default, hit a record spread of more than 500 bps on Monday.
Under pressure from the ECB to cut its debt and reform its economy, Berlusconi's center-right government has promised to balance the budget by 2013 and pass other measures to boost Italy's creaking economy.
But it has drawn widespread criticism for the haphazard way it has handled the package, which underwent four major overhauls before it was presented to parliament last week following major differences within the government.
Ratings agency Moody's, which placed Italy on review for possible downgrade on June 17, may cut its AA2 debt rating as early as this week, although a senior Treasury official said on Monday Rome did not believe a downgrade was likely.
Earlier, a Treasury spokesman confirmed that Economy Minister Giulio Tremonti had met Chinese officials last week but he declined to confirm a Financial Times report that Italy was asking Beijing to buy substantial quantities of Italian debt.
The spokesman declined to comment on the substance of the meeting with a delegation that a second source said included the head of China Investment Corp Lou Jiwei and officials in charge of investment and fixed income. There were separate meetings with state investment agency Cassa Depositi e Prestiti.
Similar reports that Beijing was buying peripheral euro zone bonds have not proved conclusive in the past.
The head of Italy's largest manufacturer Fiat warned that there was a risk that the system goes off the rails, unless governments took urgent action to restore confidence but he appeared skeptical about the prospects of help from China.
If the Chinese are willing to invest, they are welcome, God bless them. But the fact that we had to go there (to China) asking for money is not a good sign, Fiat Chief Executive Sergio Marchionne told reporters at the Frankfurt car show.
Two weeks ago, Italian officials were in Beijing to meet CIC and China's State Administration of Foreign Exchange (SAFE), which manages the bulk of China's foreign exchange reserves, the FT said. CIC is a sovereign wealth fund managing $300 billion.
The Italian Treasury spokesman gave no indication that bond-buying was discussed.
With about a quarter of China's record foreign currency reserves of $3.2 trillion estimated by analysts to be held in euro assets, Chinese leaders have repeatedly voiced support for the debt-mired single currency area.
There was no confirmation from Beijing of any concrete buying of Italian bonds. (Additional reporting by Stefano Bernabei, Gavin Jones in Rome, Silvia Aloisi in Frankfurt, Kevin Yao in Beijing, Brian Gorman in London)
(Writing by James Mackenzie; editing by Patrick Graham)