Italian troubles deepen as cost of borrowing surges

The scale of the pressure on Italy's creaking public finances was underlined today as markets jacked up its cost of borrowing to a three-year high.

Italy - seen as the next potential eruption in Europe's sovereign debt crisis - tapped bond markets for €5 billion (£4.4 billion) but was forced to pay 4.93% and 5.9% respectively for five and 15-year debt. This is the highest since June 2008.

The troubled nation has moved to the eye of the storm in the crisis over the past week, with investors driving up its cost of borrowing and dumping shares in its banks.

The auction came as the Italian parliament voted through an tougher €47 billion austerity package today in a bid to slash the deficit and soothe market nerves.

Bond traders have targeted Italy amid fears over the nation's debt mountain, which is expected to stretch to 119% of the country's output this year.

Italian bond yields blew out to record levels above 6% on Tuesday before the European Central Bank intervened to buy up debt.

A bailout for Italy - Europe's third-biggest economy and the world's largest bond market - would dwarf previous rescues for Greece, Portugal and Ireland.

The International Monetary Fund yesterday warned the nation to take "decisive" action to slash its deficit, and forecast a slowdown in growth from 1.3% to 1% this year.

Today's auction was seen as a vital test of its ability to borrow money in the markets as political splits also raise questions over the nation's commitment to spending cuts.

"The Italian auctions were well received under the circumstances in terms of volume demanded by the market as well as some decent overbidding," said Orlando Green, strategist at Crédit Agricole CIB.

But WestLB strategist Michael Leister warned: "The big picture - the risk of a self-sustaining vicious yield-downgrade circle - remains unchanged."