MILAN — Italy's borrowing rates skyrocketed during bond auctions Friday, temporarily battering stock markets in Europe as the continent's escalating debt crisis laid siege to the eurozone's third-largest economy.
Italy's new government under economist Mario Monti faces a battle to convince investors it has a strategy to cut down the country's €1.9 trillion ($2.6 trillion) debt. The auction results are also likely to fuel calls for the European Central Bank to use more firepower to cool down a rapidly escalating debt crisis.
Driving market fears is the knowledge that Italy is too big for Europe to bail out, like it has done with smaller nations Greece, Portugal and Ireland. Italy must refinance $200 billion by next April alone, but too-high borrowing rates can fuel a potentially devastating debt spiral that could bankrupt the country.
Friday's auctions showed that investors see Italian debt as increasingly risky. The country had to pay an average yield of 7.814 percent to raise €2 billion ($2.7 billion) in two-year bills — sharply higher than the 4.628 percent it paid in the previous auction in October. And even raising €8 billion ($10.7 billion) for six months proved exorbitantly expensive, as the yield for that spiked to 6.504 percent, nearly double the 3.535 percent rate last month.
Following the grim auction news, Italy's borrowing rates in the markets shot higher, with the ten-year yield spiking 0.34 percentage point to 7.30 percent — above the 7 percent threshold that forced other nations into bailouts.
Markets so far appeared to be giving Monti no honeymoon since he took power a week ago.
"Mario Monti has failed so far to impress bond markets he has the power and authority to do what is required," said Louise Cooper, markets analyst at BGC Partners.
Solid returns on Wall Street then helped European markets recover from earlier losses Friday.
Italy was not the only member of the 17-nation eurozone to have a disappointing auction this week. Even Germany — the region's strongest economy and the main funder of eurozone bailouts — suffered a shock Wednesday when it failed to raise all the money it sought, its worst auction result in decades. Spain also saw its borrowing rates ratchet sharply higher even after a landslide victory for the conservative Popular Party, which has made getting Spain's borrowing levels down its top priority.
Contagion over Europe's debt crisis also hit Hungary and Belgium. Moody's downgraded Hungary's sovereign debt to junk status, a decision that government hotly criticized. Hungary is not a member of the eurozone, but trades with many eurozone members. And the Standard & Poor's ratings agency downgraded long-term Belgian debt on Friday, citing a threat to its exports.
Monti emphasized his intention to balance Italy's budget by 2013 and to introduce "fair but incisive" structural reforms," his office said following a Cabinet meeting Friday.
Monti also has pledged to reform the pension system, re-impose a tax on homes annulled by Berlusconi's government, reduce tax evasion, streamline civil court proceedings, get more women and youths into the work force and cut political costs.
Olli Rehn, the EU's monetary chief, told reporters Italy's economic fundamentals were "solid" and praised Monti's economic reforms as "going in the right direction" but said more action was needed.
Monti's medicine — budget rigor and growth measures while fairly distributing the social pain — are "the right ones," Rehn said after meeting in Rome with the Italian leader. "I fully endorse them."
Rehn told Italian lawmakers they must implement the measures quickly.
"Over the longer term, productivity will depend on a well-educated labor force," Rehn said. "I am particularly concerned about high unemployment, which is a tremendous waste of talent that Europe simply cannot afford."
This week's developments have ratcheted up the pressure on the European Central Bank to step up its bond purchases in the markets, though Germany remains adamantly opposed. The current program is designed to support bond prices in the markets, thereby keeping a lid on the borrowing rates.
So far, the ECB has been buying limited amounts of bonds and has to sell an equivalent amount of assets. The ECB said Monday it bought bonds worth only €4.5 billion ($6 billion) last week, down from €9.5 billion ($12.7 billion) a week earlier.
Potentially, the ECB has unlimited financial firepower through its ability to print money and many countries in the eurozone, including France, want the bank to act more decisively to solve the debt crisis.
However, Germany finds the idea of monetizing debts unappealing, warning that it lets more profligate countries off the hook for their bad practices.
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