ROME/BERLIN - Italian borrowing costs reached breaking point on Wednesday after Prime Minister Silvio Berlusconi's insistence on elections instead of an interim government opened the way to prolonged instability and delays to long-promised economic reforms.
RELATED:Greek PM steps down to make way for coalition gov't Berlusconi to resign after parliamentary setback
In a dramatic escalation of the euro zone debt crisis, Italian 10-year bond yields shot above the 7 percent level that is widely deemed unsustainable, reflecting an evaporation of investor confidence and prompting German Chancellor Angela Merkel to issue a call to arms.
Merkel said Europe's plight was now so "unpleasant" that deep structural reforms were needed quickly, warning the rest of the world would not wait. "That will mean more Europe, not less Europe," she told a conference in Berlin.
She called for changes in EU treaties after French President Nicolas Sarkozy advocated a two-speed Europe in which euro zone countries accelerate and deepen integration while an expanding group outside the currency bloc stayed more loosely connected -- a signal that some members may have to quit the euro if the entire structure is not to crumble.
"It is time for a breakthrough to a new Europe," Merkel said. "A
community that says, regardless of what happens in the rest of the
world, that it can never again change its ground rules, that community
simply can't survive."
Portugal and Ireland were forced to seek EU-IMF bailouts when their
borrowing costs reached similar levels and clearing house LCH.Clearnet
sounded another alarm by increasing the margin it demands on debt from
the euro zone's third largest economy, effectively raising the cost of
holding Italian bonds.
The European Central Bank, the only effective bulwark against market
attacks, wasted no time intervening to buy Italian bonds in large
amounts but remains reluctant to go further.
"The ECB is buying aggressively," one trader said.
Italy has replaced Greece at the centre of the euro zone debt crisis and
is on the cusp of requiring a bailout that Europe cannot afford to
Unlike Greece, an Italian default would threaten the entire euro
project. EU treaty changes could take a year or more. Rome does not have
that much time.
Euro zone officials said a bailout of Italy was not being planned for.
"Financial assistance is not in the cards," one official said, adding
that the bloc was not even considering extending a precautionary credit
line to Rome.
Having lost his majority in a key parliamentary vote, Berlusconi
confirmed he would resign after implementing economic reforms demanded
by the European Union, and said Italy must then hold an election in
which he would not stand.
He opposed any form of transitional or unity government -- which the
opposition and many in the markets favour -- and said polls were not
likely until February, leaving a three-month policy vacuum in which
markets could create havoc.
Italian President Giorgio Napolitano, expressing alarm about a collapse
in market confidence, said there was no doubt about the resignation of
Berlusconi once economic reforms were implemented by parliament within
"Therefore, within a short time either a new government will be formed
... or parliament will be dissolved to immediately begin an electoral
campaign," Napolitano said.
Even with the exit of a man who came to symbolise scandal and empty
promises, it will not be easy for Italy to convince markets it can cut
its huge debt, liberalise the labour market, attack tax evasion and
"There is no guarantee (Berlusconi's) successor will be able to do a
better job. Just keep your eyes on the Italian yield for now," Christian
Jimenez, fund manager and president of Diamant Bleu Gestion, said.
While Italian bonds blew out, worries that the debt crisis could be
infiltrating the core of the euro zone were reflected in the spread of
10-year French government bonds over their German equivalent blowing out
to a euro era high around 140 basis points.Running the risk of a 'lost decade'
Policymakers outside the euro area kept up pressure for more decisive action to stop the crisis spreading.
Christine Lagarde, head of the International Monetary Fund, told a
financial forum in Beijing that Europe's debt crisis risked plunging the
global economy into a Japan-style "lost decade".
"Our sense is that if we do not act boldly and if we do not act
together, the economy around the world runs the risk of downward spiral
of uncertainty, financial instability and potential collapse of global
demand ... we could run the risk of what some commentators are already
calling the lost decade."
Berlusconi has reluctantly conceded that the IMF can oversee Italian reform efforts.
Euro zone finance ministers agreed on Monday on a roadmap for leveraging
the 17-nation currency bloc's 440-billion-euro ($600 billion) rescue
fund to shield larger economies like Italy and Spain from a possible
But there are doubts about the efficacy of those complex plans, and with
Italy's debt totalling around 1.9 trillion euros even a larger bailout
fund could struggle to cope.
Lagarde said she was hopeful the technical details on boosting the
European Financial Stability Fund (EFSF) to around 1 trillion euros
would be ready by December.
Many outside Europe are calling on the ECB to take a more active role as
other major central banks do in acting as lender of last resort. German
opposition to that remains implacable, seeing it as a threat to the
central bank's independence.
But with the ECB just about the only buyer of Italian bonds, according
to traders, it will have to act more aggressively to contain the latest
wave of crisis, despite internal opposition to its bond-buying
"The ECB will be drawn like every one else by the weight of gravity (to act)," a second euro zone official said.Greek Drama
With the markets' fire turned firmly on Italy, Greece's struggle to find
a new prime minister became something of a sideshow, but one which
demonstrated the difficulty in taking decisive action anywhere within
the euro zone.
Greek Prime Minister George Papandreou said he was stepping down without
saying who would succeed him as the nation heads towards bankruptcy,
but party sources said leaders had agreed it would be the speaker of
Parties from left and right settled on veteran socialist Filippos
Petsalnikos, barring-last minute snags, the sources said, turning to
their own political class after ditching a plan to recruit a former top
European Central Bank official.
The socialist and conservative parties had wanted former ECB
vice-president Lucas Papademos to lead a government of national unity
but he appears to have made demands about his level of influence which
they could not swallow.