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.
The auction results are another sign that Italy's new technocratic 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. They 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. Given the size of its debts — Italy must refinance $300 billion next year alone — the government has to continually tap investors for money. But when borrowing rates get too high, that can fuel a potentially devastating debt spiral which 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 helped European markets recover from earlier losses Friday fueled by fears over Italy.
Italy was not the only country in 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 election victory for the conservative Popular Party, which has made getting Spain's borrowing levels down its top priority.
Monti, who replaced Silvio Berlusconi as Italy's leader, has pledged to quickly implement new austerity measures followed by deeper reforms. He spent much of his first week in office meeting with European Union officials and the leaders of France and Germany laying out his plans.
During the meetings, Monti emphasized his intention to balance the budget by 2013 and to introduce "fair but incisive" structural reforms," his office said in a statement 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.
EU monetary affairs commissioner Olli Rehn told the Italian Parliament that "full and effective implementation will be key."
He urged a "clear and ambitious roadmap for reform and an ambitious timeline" and expressed particular concern about low employment among Italian youth.
"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."
Rehn was in Rome to monitor Italy's compliance with promises to liberalize its labor market, reduce the bloated public sector and sell off some state assets.
There were also signs that contagion over Europe's debt crisis was moving eastward. Moody's downgraded Hungary's sovereign debt to junk status — from Baa3 to Ba1 with a negative outlook — a decision Hungary hotly criticized. Hungary is not a member of the eurozone, but trades with many eurozone members.
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 the more profligate countries off the hook for their bad practices.