Spain's short-term borrowing costs hit a 14-year high on Tuesday as political uncertainty about a solution to the euro zone's sovereign debt crisis punished another vulnerable southern European country.
European Union paymaster Germany continues to block the two most widely-touted exit routes from a crisis that is shaking the world economy -- massive European Central Bank intervention to buy government bonds, or joint issuance of euro zone debt.
Influential ECB policymaker Jens Weidmann, head of Germany's Bundesbank, spelled out his rejection of the former in a speech to employers in Berlin.
(The ECB) would overstretch its mandate and call into question the legitimacy of its independence by accepting a role of lender of last resort for highly indebted member states, Weidmann said.
Anyone who believed the crisis could be overcome by giving up stability-oriented principles, and by pushing aside existing legislation, was wrong, he said. To do that would be like drinking sea water to kill thirst.
German Chancellor Angela Merkel called for much tougher rules to override national budget sovereignty if euro zone states failed to follow agreed EU rules.
It was not very appropriate to discuss euro zone bonds now, since mutual debt guarantees could come only at the end of a European integration process, if at all, she said.
Average yields on Spanish 3- and 6-month treasury bills soared by around 2 percentage points in an auction seen as a test of investor sentiment after the conservative People's Party won an absolute majority in Sunday's general election.
Prime Minister-elect Mariano Rajoy disappointed investors by refusing to give any clearer indication of his austerity plans or his choice of economy minister until he is sworn in on December 20, leaving the kind of policy vacuum that markets abhor.
Credit ratings agency Fitch said Spain's new government would need to enact additional savings measures to meet its existing fiscal targets and had a window of opportunity to do so with a fresh mandate.
If it is to improve market expectations of its capacity to grow and reduce debt within the confines of the eurozone, it must positively surprise investors with an ambitious and radical fiscal and structural reform programme, Fitch said.
The ECB has been sporadically buying Spanish and Italian government bonds to prevent prices spiking to unaffordable levels, but the limited, stop-go purchases have failed to provide durable relief.
The yields are a reflection of where their paper trades in the secondary market but if it wasn't for the European Central Bank, there wouldn't be a Spanish or Italian bond market, said Gary Jenkins, head of fixed income at Evolution Securities.
New Italian Prime Minister Mario Monti outlined his reform plans in Brussels as Italy's two-year bond yields rose back above 10-year yields in a sign of market stress, prompting the ECB to buy short and medium-term Italian paper, dealers said.
European Commission President Jose Manuel Barroso said Monti's reform programme correctly addressed the enormous challenges facing Italy, which must pursue its efforts to regain investors' confidence. There was no mention of any financial support for Rome, whose borrowing costs have touched levels at which Greece, Ireland and Portugal applied for bailouts.
In an indicator of how sovereign debt problems have virtually frozen inter-bank lending markets, euro zone banks' demand for ECB funds surged to a two-year high.
The ECB's weekly, limit-free handout of funding underscored the widespread problems with 178 banks requesting a total of 247 billion euros (213 billion pounds), the highest amount since the peak of the global financial crisis in mid-2009.
Investors in Europe and beyond have been cutting their exposure to euro zone government bonds as the two-year-old debt crisis has spread even to core countries such as France, Austria and the Netherlands.
Belgian bond yields spiked on Tuesday after the man widely seen as most likely to form a government and end an 18-month political crisis submitted his resignation to King Albert due to a deadlock over the 2012 budget.
Belgium has come under market pressure over its lack of a new government and sovereign debt nearly as big as its GDP, and its cost of borrowing jumped again to 5.1 percent for 10-year bonds after Socialist Elio Di Rupo threw in the towel.
Faced with an accelerating rout on European bond markets, Merkel has insisted the only answer is for states to implement painful austerity measures and structural reforms to make their economies more competitive.
She has also pressed for the euro zone's rescue fund to speed up plans for scaling up its firepower to provide bond insurance and credit enhancements for foreign investors.
Euro zone finance ministers are due to approve detailed proposals next Monday, but analysts have voiced strong doubts about the prospects of achieving the 1 trillion euros in leverage targeted by EU leaders at a summit last month.
Echoing Merkel's call for stricter fiscal discipline, Economic and Monetary Affairs Commissioner Olli Rehn said the EU executive would seek more intrusive powers to make sure national budgets in the euro zone do not break agreed rules.
The Commission will call for balanced budget rules to be inscribed into national law, prefrably the constitution. It will also propose that budget planning be done on the basis of forecasts by national fiscal councils independent of government.
Rehn said a proposal from the German government's panel of independent economic advisers for a euro zone debt redemption fund that would mutualise the bloc's debt stock on stringent conditions was worth further study.
Merkel has questioned the legality of the idea and said it would be impossible to implement in reality.
In Greece, the starting point of the euro zone debt crisis, a standoff continued over the main conservative party leader's refusal to sign a written commitment to austerity measures.
Dutch Finance Minister Jan Kees de Jager said euro zone finance ministers would not approve the release of a desperately needed 8 billion euro aid instalment next week unless Antonis Samaras of New Democracy gave a written pledge.
Saying that words are enough -- we've passed that stage. We want a signature from this Mr Samaras, De Jager told RTL7 tv.
Greek private sector workers announced plans for a one-day strike on December 1, the first since technocrat Prime Minister Lucas Papademos took office at the head of a national unity government, to protest against austerity and welfare cuts.
(Additional reporting by Emelia Sithole-Matarise and Ana Nicolaci da Costa in London, Paul Carrel in Frankfurt, Robert-Jan Bartunek in Brussels, Gilbert Kreijger in Amsterdam, Harry Papachristou in Athens; Writing by Paul Taylor; editing by Janet McBride and David Stamp)