Euphoria from this week's Eurozone debt deal has evaporated after Italy’s latest bond auction as a lack of appetite for its ten-year bonds forced it to pay record yields to get the sale off the ground.
In a sign of market scepticism that the Eurozone is safe from further debt problems, Italy had to sell its €7.9bn (£6.9bn) of long-dated bonds at yields of more than six per cent, the highest it has paid since it joined the single currency.
Italy's borrowing costs were barely below of the level reached just before the European Central Bank intervened in August to cap Rome's borrowing costs by buying Italian paper.
The Eurozone's third largest economy is once more at the centre of the debt crisis, with fears growing that its borrowing costs could rise to levels that overwhelm the capacity of the bloc to provide support.
The result also raised new questions about whether Italy's struggling government led by prime minister Silvio Berlusconi can deliver vital reforms.
In a speech in Rome Berlusconi, tainted by scandal and repeatedly at odds with his coalition allies, said the record yield would weigh on the country's finances, but insisted Italy would meet its target of balancing the budget by 2013.
In his speech Berlusconi took aim at the euro, calling it a "strange" currency.
"There is an attack on the euro which, as a currency, has convinced no-one because it belongs to more than one country but does not have a bank of reference and guarantee," he said, referring to reluctance by Germany and other countries to allow the European Central Bank to be used as a lender of last resort.
France and Germany have expressed open exasperation at a succession of unfulfilled reform promises by Berlusconi and fear the crisis in Italy could spark a wider emergency that would threaten the very existence of the single currency.
Even if a weakened government manages to pass the difficult reforms Berlusconi has promised, most would not come into force until the middle of next year. Markets are unlikely to remain patient during such a long delay.
CMC Markets analyst Michael Hewson said the poor auction result “reminded investors, if any reminder were needed, that Italy remains a key fault line in the European debt crisis.”
Financial stocks immediately gave up yesterday’s gains, led by Lloyds, which closed down 5.2 per cent, hedge fund Man Group, which lost 4.7 per cent, and Barclays, down 4.2 per cent.
RBS lost 3.6 per cent while Europe-focused insurer Aviva closed 3.3 per cent down.
Adding to concerns, the head of Europe's bailout fund played down hopes of a quick deal with China to throw its support behind efforts to resolve the crisis. But said he expected Beijing to continue to buy bonds issued by the rescue fund.
"I think we have a long way to go with this (European debt) mess. I still see huge risks," Stanley J.G. Crouch, who oversees $2bn as the chief investment officer of Aegis Capital in New York.