Eurozone crisis makes early return as Italy and Spain suffer

The eurozone's sovereign debt worries moved back towards crisis yesterday as Spanish and Italian borrowing costs touched levels that triggered the Greek, Irish and Portuguese bailouts.

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The interest demanded by investors to lend money to Spain for 10 years soared to 6.47 per cent at one point. For Italy, the figure rose as high as 6.27 per cent, unsettlingly close to the 7 per cent threshold that left Greece, Ireland and Portugal in need of emergency funding. In both cases, the rates demanded were the highest since 1997.

In a sign of the growing concern about Rome's debt burden, the yield on five-year Italian bonds rose to hit parity with Spain's briefly. The jump marks a shift from the almost-singular focus on Madrid after Portugal was forced to ask for a bailout earlier this year. Italian stock markets were also caught in the crossfire, falling to their lowest in more than two years.

Amid the turmoil, the Italian economy minister, Giulio Tremonti, called an emergency meeting with the central bank, the market regulator and the country's insurance authority. The talks came ahead of an address on the crisis by the Prime Minister, Silvio Berlusconi, who is due to speak in parliament today. Spanish politicians were similarly rattled, with Prime Minister Jose Zapatero delaying his holiday to monitor the situation as markets convulsed.

Analysts said the market worries were down to a number of factors, including a Spanish bond auction on Thursday, and the release of quarterly growth figures for Italy on Friday. The turmoil was also blamed on the fact that the European Central Bank (ECB) had stopped buying EU government bonds to soothe markets.

Although the second Greek rescue package agreed 10 days ago includes powers for the EU bailout fund to purchase the bonds instead of the ECB, those powers need to be ratified by member states, according to David Owen, chief European financial economist at Jefferies. That could take months, he warned. "The market is testing the ECB," Mr Owen said. "If this bailout fund is not going to be around to buy bonds, then let's see if the ECB will do it."

Jean-Claude Trichet, the ECB president, has a chance to address that issue when he holds a regular press conference tomorrow.

As Spain's and Italy's borrowing costs went up, Germany's fell sharply. The rush into Germany by investors seeking a safe haven drove the yield on the country's 10-year bonds to as low as 2.395 per cent – below Germany's 2.4 per cent inflation rate. As a result, the real bond yield, adjusted for inflation, stood at zero for the first time in half a century.

The flight to safety also meant that the premiums demanded by investors to hold Spanish and Italian bonds over German bunds touched new highs, spiralling to 400 basis points and 380 basis points respectively.

Gilts shine amid turmoil

The flip side of the re-emergence of Europe's sovereign debt crisis yesterday was renewed demand for British government bonds, which are seen as a relative safe haven in the crisis. That drove the UK's borrowing costs to a record low, with yields on 10-year gilts falling to 2.76 per cent at one point, the lowest in history. In addition to concern about the European situation, investors took their cues from a raft of negative economic data out of the US, which triggered further worries about global growth. Gilts were also deemed attractive amid fears that, despite the recent political deal to raise the debt ceiling, the US may yet lose its prized "AAA" credit rating.