Italy can sustain borrowing rates of 8% and zero economic growth, the central bank said in a report today after market panic fanned fears that Italy could be dragged into a debt spiral.
The report said the Bank of Italy had tested "an extreme hypothesis" that the rates on all new bond issues rise 2.5 percentage points higher than a current average calculated at 5.5% starting in January 2012.
The test found Italy could still reduce its debt under the scenario to 115.5% of output by 2014 from the current level of around 120%. The Bank of Italy also tested another scenario of zero growth between 2012 and 2014 and found debt would remain broadly stable at just above 120%.
The yield on Italian 10-year government bonds shot up to 6.33% yesterday - perilously close to its highest ever level of 6.4% reached in October - and the rate on two-year and five-year bonds hit record peaks.
The rate lowered slightly to 6.23% today while the spread between borrowing rates on Italian and German benchmark 10-year bonds was at 436 basis points - lower than its record but still at a very high level.
Italian analysts have warned that borrowing rates above a 6% threshold on 10-year bonds would make it difficult for Italy to continue financing itself on commercial debt markets within a few months.
Emergency meetings to speed up austerity reforms
Italy held emergency meetings today to speed up reforms ahead of the G20 summit in a bid to put out the spreading flames of the euro zone debt crisis, as talk of a government change gained pace.
Prime Minister Silvio Berlusconi met Finance Minister Giulio Tremonti to discuss proposals aimed at slashing Italy's debt and boosting growth. The Treasury also hosted financial stability talks, a day after market turmoil signalled fears that Italy is the next euro crisis victim.
Berlusconi promised to launch some reforms before the start of the G20 talks in a phone call with German Chancellor Angela Merkel yesterday, as Italian stocks plunged and borrowing rates hit record highs.
The Milan stock market closed down 6.8% yesterday - its worst session since October 2008 at the start of the global financial crisis - fanning investor fears that Italy could be dragged into a debt spiral like Greece, Ireland and Portugal. The stock market picked up today, closing 2.4% higher this evening.
Italy is the euro zone's third largest economy and economists warn that rescuing it could prove impossible, unlike for smaller economies that have already been forced to seek bailouts because of high borrowing rates.
Among the reform measures being discussed are a liberalisation of professional orders like lawyers and dentists to boost competition, a series of major privatisations and an increase in the pension age to 67.
The government is under pressure to act quickly on the long-promised measures but there is concern this could bring down the government.
Berlusconi's popularity ratings have hit a record low of 22% according to the latest poll released today and the centre-left opposition has called on the scandal-tainted prime minister to resign.