Italy had to pay an average yield of 7.814% in latest auction of two-year bills, sharply higher than the 4.628% rate paid in its previous auction, a sign that Europe's debt crisis has spread to the eurozone's third-largest economy

Cindy Allen

ROME , November 25, 2011 (Associated Press) – Italy had to pay sharply higher borrowing rates to entice investors to part with their cash during a couple of auctions Friday, in an acute sign that Europe's crippling debt crisis is laying siege to the eurozone's third-largest economy.

The auction results are another sign that the country's new technocratic government faces a big battle to convince investors that it has a strategy to get a grip on the country's massive debts, and are likely to fuel calls for the European Central Bank to use its firepower to ease a debt crisis that's shown alarming signs of getting much worse this week.

Premier Mario Monti, who replaced Silvio Berlusconi last week, has pledged new austerity measures quickly followed by deeper reforms, and has spent much of his first days in office meeting with European Union officials and the leaders with France and German laying out his plans to get the country's debt burden down.

Italy's debts, which stand at euro1.9 trillion ($2.6 trillion), or a huge 120 percent of economic output, are too big for the eurozone's current anti-crisis measures to deal with.

Given the size of its debts, Italy has to continually come to the markets to tap investors for money. The problem arises when the rates it has to pay get so high that the actual debt burden increases — fueling a potentially-devastating debt spiral.

Friday's auctions indicated that investors are finding it an increasing risk holding onto Italian debt. The country had to pay an average yield of 7.814 percent to raise euro2 billion in two-year bills. That rate was sharply higher on the 4.628 percent it had to pay in the previous auction. And even raising euro8 billion for six months proved exorbitantly expensive. The yield for this auction spiked to 6.504 percent, nearly double the 3.535 percent rate in the last equivalent auction.

Following the grim news on the auction front, the country's borrowing rates in the markets skyrocketed, with the ten-year yield spiking 0.34 percentage point to 7.30 percent — above the 7 percent threshold that is widely-considered unsustainable in the long-run and eventually proved the point at which Greece, Ireland and Portugal had to seek financial bailouts.

Italy is not alone in the 17-country eurozone in experiencing a disappointing auction this week. Even Germany suffered a flop on Wednesday when it failed to raise all the money it sought, its worst result in decades. Spain too saw its borrowing rates ratchet sharply higher even after a landslide election victory from the conservative Popular Party, which has made getting the country's borrowing levels down its number one priority.

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 euro4.5 billion last week, down from euro9.5 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, have indicated that giving the bank more free reign will help solve the debt crisis.

However, Germany finds the idea of monetizing debts unappealing, warning that it lets the more profligate countries off the hook for their bad practices. In addition, it conjures up bad memories of hyperinflation in Germany in the 1920s.

Monti has pledged to reform the pension system, re-impose a tax on homes annulled by Berlusconi's government, fight tax evasion, streamline civil court proceedings, get more women and youths into the work force, and cut political costs.

While the deeper reforms will take more time, Monti has said the government would decide new austerity measures to address the crisis "in the coming weeks." He has pledged to balance the budget by 2013, something that the EU has said would take additional measures.

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