Italian debt costs shoot back into danger zone

Despite a successful debt auction, Rome's 10-year borrowing costs rise above critical level

Hopes that Italy was emerging from the economic danger zone were dashed yesterday as Rome's long-term borrowing costs shot above 7 per cent, an interest rate widely regarded as unsustainable.

The Italian government managed to sell €2.5bn (£2.1bn) of 10-year debt at an interest rate of 6.98 per cent, down from 7.56 at a similar auction last month. But traders soon pushed Italian 10-year debt above the 7 per cent level, thwarting hopes of policymakers that this week's auctions of Italian government paper – the first since the administration of Mario Monti pushed through an austerity package earlier this month – would mark a revival of investor confidence in the solvency of the Italian government.

Demand for the bond issue was also disappointing, with the total €7bn placement of notes falling short ofthe Italian government's upper target of €8.5bn.

Italy's short-term debt costs halved earlier this week when Rome managed to sell €9bn-worth of six-month bills on Wednesday at an average yield of 3.25 per cent (down from a euro-era high of 6.5 per cent last month), giving some investors hope that the debt market's faith in Italy was picking up. But 10-year bond yields are the more critical measure of confidence and the fact that Italy's long-term borrowing costs are still hovering around the 7 per cent mark shows that Italy remains in the grip of a financial crisis.

"Buying 10-year Italian paper is a leap of faith that investors are willing to undertake only at punitive interest rates," said Nicholas Spiro, managing director of London-based Spiro Sovereign Strategy. The yield also stayed high despite reports of agents of the European Central Bank buying up Italian debt in the secondary markets.

Mr Monti welcomed the fact that Italy managed to offload its latest tranches of debt, but admitted that his government had not yet won the confidence of investors. "Auctions held yesterday and today went rather well, but the financial turbulence absolutely isn't over," he said.

Italy needs to roll over a total of €440bn in the bond market in 2012 in order to avoid a default on its €1.9 trillion sovereign debt pile. The Italian parliament has approved an austerity package brought forward by Mr Monti for €33bn of tax hikes, pension reforms and spending cuts. But most economic analysts believe Italy is already sinking back into recession. This threatens to push up borrowing levels and make it more difficult for Rome to convince the financial markets of its solvency. "Bond market credibility next year is going to be more about growth than austerity," warned Mr Spiro.

UK bond yields hit record low

Britain's borrowing costs fell to an all-time low yesterday. The yield on 10-year gilts dipped to 1.96 per cent in a thinly traded market. Some analysts suggested that investors were looking to park funds in ultra-safe assets ahead of year-end accounting. But others said that the low yield indicated a market acceptance that the UK economy will continue to weaken throughout 2012, prompting the Bank of England to keep interest rates at a record low and to extend its £275bn gilt buying programme.