Italy debt sale raises euro zone stress

Italy paid a record 6.5 per cent to borrow over six months on Friday and its longer-term borrowing costs soared far above levels seen as sustainable for public finances, raising the pressure on the euro zone's debt-stricken third biggest economy.

The yield on the six-month paper almost doubled compared to a month earlier and showed the appointment of an emergency government to tackle the debt crisis had failed to put a brake on Rome's spiralling borrowing costs.

Though Italy managed to raise the full planned amount of €10 billion, weaker demand and the highest yields since the country joined the euro frightened investors, pushing Italian stocks lower and bond yields higher on the market.

Yields on two-year Italian BTP bonds soared to more than 8 per cent in response, also a euro lifetime high, despite reported purchases by the European Central Bank.

"The pricing is awful," said Padhraic Garvey, rate strategist with Dutch bank ING in Amsterdam.

"The object of the exercise this morning was to get the job done and they've done that, but that's about the only positive thing to say."

The euro, already trading around a 7-week low, inched down after the auction. European stock markets remained deep in negative territory for the day.

In a sign of the intense stress on Italy, short-term yields have climbed back above those of longer-dated issues this week. But, ranging from 7.35-8 per cent, all are now well above the 7 per cent threshold that is widely seen as unsustainable for the country's public finances.

By comparison, Spain paid 5.2 per cent to sell six-month paper at a much smaller short-term auction earlier this week after elections handed power to an austerity-committed conservative government.

The auction yield on the six-month bills that Italy sold on Friday stood at 3.5 per cent a month ago.

Italy also sold €2bn of zero-coupon CTZ bonds at a euro era record high yield of 7.8 per cent, up from 4.6 per cent at the previous sale.

The sovereign crisis gripping the euro zone escalated this week after a German Bund auction met poor demand, highlighting the growing threat of contagion from weaker peripheral countries such as Italy to healthier core economies.

Adding to investors' worries, a meeting of the leaders of Germany, France and Italy on Thursday offered no immediate progress in tackling the crisis.

Saddled with a debt pile running at 120 per cent of gross domestic product and anaemic growth, Italy has moved to the fore of the debt crisis since early July.

Italy plans to sell up to €8bn of bonds, including a new three-year one, at an auction on Tuesday.