Investors unnerved by eurozone uncertainty

Uncertainty in the eurozone continued to unnerve investors today as London's leading shares index endured a day of volatile trading.

The FTSE 100 Index closed 0.2% lower after the European Commission slashed its growth forecasts for the eurozone, highlighting the underlying problems faced on the continent.

The gloomy figures overshadowed a slight improvement in Italy's borrowing costs, which had soared into unsustainable territory in recent days amid fears over the country's huge debts and weak growth.

Italy's 10-year bond yield was back below the critical 7% mark following a better-than-expected debt auction and signs that prime minister Silvio Berlusconi could be out of office by the weekend.

Mr Berlusconi was largely seen as an obstacle to pulling Italy, which is the eurozone's third-largest economy and has debts worth 120% of national income, from a financial mire.

But the mood was dominated by troubling forecasts from the EC, as it warned the 17-country eurozone could slip into "a deep and prolonged recession" as early as next year. The EC cut its eurozone growth estimate to 0.5% in 2012, from 1.8%.

Azad Zangana, European economist at asset management giant Schroders, said: "We believe that the outlook for the eurozone economy is now significantly more negative and that politicians have missed their opportunity to prevent a European credit crunch."

Markets have suffered losses in recent days as the yield on Italian 10-year bonds climbed to the levels that pushed Ireland and Portugal into multibillion-pound bailouts from the EU and IMF.

But borrowing costs settled after the Italian government easily sold five billion euros (£4.2 billion) worth of 12-month bonds at an interest rate of 6.1%, with high demand reported.

Raj Badiani, analyst at IHS Global Insight, said: "Italy can still stumble out of the current crisis.

"We continue to argue that Italy is better placed than the bailed-out peripherals, helped by its sounder budgetary position alongside markedly healthier private-sector fundamentals with regards to debt and wealth levels."

German and French officials have reportedly discussed plans to break up the eurozone, with weaker countries leaving the 17-nation currency bloc, while the remaining nations push towards greater integration.

The discussions come amid fears that a debt default by Greece or even Italy could sink the eurozone and cause chaos on financial markets.

The wavering sentiment hit the banking sector, which is exposed to £10.9 billion worth of Italian debt, with Barclays down 1% and Lloyds Banking Group off 0.4%.

Prime Minister David Cameron said Italy posed "a clear and present danger to the eurozone", while German Chancellor Angela Merkel pressed it to clear up quickly who will run the country.

Elsewhere, former European Central Bank vice president Lucas Papademos was named as Greece's interim prime minister of a new unity government after four days of power-sharing talks.

The announcement will offer some reassurance towards the debt-laden country, which has experienced a tense political upheaval in recent weeks.

There was some cheer on the other side of the Atlantic, where the number of people who applied for unemployment benefits in the United States last week fell to the lowest level since April, which suggests employers could be stepping up hiring.

Elsewhere, figures showed the US trade deficit fell in September to the lowest point this year as sales of American-made cars, aeroplanes and heavy machinery pushed exports to an all-time high.

PA