Record borrowing costs put Italy at centre of crisis

Relief at European debt deal fades as Rome struggles at first test since Brussels summit

Fear made a swift return to the eurozone yesterday as Italy faced record borrowing costs in its first attempt to tap the markets since European leaders came up with new plans to rein in the sovereign debt crisis.

The lack of confidence in their proposals was laid bare when Rome would was forced to pay interest rates of more than 6 per cent to borrow money for 10 years by selling new bonds. The rate – the highest for new 10- year bonds since the country adopted the single currency – reignited concerns about Europe's ability to deal with the crisis as it threatened to spread to countries that are seen as too big to bail out.

Less than 36 hours before the Italian bond sale, leaders agreed proposals to reduce Greece's debt burden by asking private investors to take voluntary losses of around 50 per cent on their holdings of the country's debt. Plans for the so-called haircut on Greek bonds were accompanied by proposals to recapitalise banks and implement sweeping guarantees on bank funding as politicians attempted to restore confidence in the markets.

But the Italian auction, which also saw three-year yields rise to 4.93 per cent, the highest since November 2000, offset any lingering optimism about the package. The record rates triggered reversals for European shares. The FTSEurofirst 300, which tracks leading European equities, turned negative after the results were publicised.

The Milan stock market also fell as the sense of crisis returned to dealing rooms. The disappointing bond auction came shortly after Italy's Prime Minister, Silvio Berlusconi, who has been facing growing pressure from France and Germany to cut his country's debt burden, attempted to counter speculation that his centre-right government could collapse as it attempts to implement wide-ranging economic reforms.

"The important thing at the moment is to maintain a cohesive majority and [for] government to pass reforms," Mr Berlusconi said.

The high borrowing rates, however, suggested that the markets were far from convinced of his ability to enact the changes needed to put Italy on a more sustainable footing. "The interest rates that they are paying are punitive," said Marc Oswald, a strategist at the institutional and corporate broker Monument Securities in London. "As far as Italy goes, it is still the bête-noire of the whole eurozone problem."

Marchel Alexandrovich, European financial economist at Jefferies, said the auction marked a return to reality as markets moved on from the initial relief to the fundamentals of high debt and low growth in troubled southern European economies.

"The announcements from the politicians led to some initial relief in the markets over the fact there was nothing bad in the deal. But now it looks as if there was nothing good either," he said, adding that, ahead of the Brussels summit, there were concerns about the prospect of mandatory haircuts on Greek debt. "It seems as if Thursday was the party, and now it's the hangover."

Gavin Nolan, the director of credit research at the financial data firm Markit, also highlighted the change in the mood among investors.

"I think [the Italian auction] is quite disappointing and it is a reminder that the announcement did not go far enough in solving the debt crisis," he said, adding that Italy had "deep-seated problems" in its economy that would take a long time to resolve.