A sharp rise in Rome's cost of borrowing yesterday forced the Berlusconi government to accelerate its economic reforms last night after another dramatic day during which the European Central Bank once again steered clear of intervening in the stricken Italian debt market.
Traders and analysts said that despite sharp market falls on Thursday, when investors reacted violently to signs that the ECB was only buying Portuguese and Irish debt, there were no signs of a change in the bank's stance on Friday.
The ECB's apparent reluctance led to investors demanding interest rates of 6.14 per cent to lend money to Italy for 10 years, against 6.03 per cent to lend to Spain, during afternoon trading. The premium that investors demand to hold benchmark Italian debt over German debt also touched a high above Spain's, highlighting the markets' perception of risk.
The rising costs kicked off frantic negotiations between European leaders, with indications that the ECB would make a broader intervention if Italy sped up certain welfare reforms. The Italian Prime Minister, Silvio Berlusconi, confirmed the fast-tracking of his plans to cut the country's deficit after stock markets closed, paving the way for the ECB to step in.
Mr Berlusconi said Italy will accelerate the measures in its austerity programme as a part of response to the market turmoil and move towards introducing an amendment enshrining the principle of a balanced budget in its constitution.
Mr Berlusconi was forced to act despite the release of positive Italian growth figures yesterday. The markets ignored news that the economy had expanded by 0.3 per cent between April and June, bettering the 0.1 per cent expansion seen over the preceding quarter, and focused instead on the limited ECB action.
Echoing concerns voiced in the hours after ECB president Jean-Claude Trichet first hinted at a renewal of central bank bond buying on Thursday, one trader in London said: "At the end of the day, unless they buy [Italian and Spanish bonds] it's going to get worse before it gets better."
The focus on the ECB reflects the fact that the recently agreedexpansion of the EU's bailout fund to encompass government bond buying needs to be ratified by member states. In the intervening period, the ECB is seen as the only body capable of moving in to calm the markets and bring down yields on Spanish and Italian debt.
The point was underlined in comments by EU policymakers, with the Economic and Monetary Affairs Commissioner saying: "The Commission fully trusts that the ECB will continue to do what is needed to preserve financial stability in the euro area and restore an appropriate monetary policy transmission channel."
But senior eurozone officials said that the onus was on member states to press ahead with reforms. "In principle it is right to say that the ECB could start buying Spanish and Italian bonds if they made an extra effort with fiscal and structural reforms," one official said.