Borrowing rates for Italy and Spain spiked to the highest levels since the global financial crisis this morning amid concern their economies, the third and fourth-biggest in the euro zone, could be sucked into a debt spiral.
In its first bond auction since its credit rating was downgraded by Standard & Poor's last week, the Italian Treasury was forced to offer sharply higher rates to attract investors to buy up €14.5 billion in debt.
The rate on six-month bonds jumped to 3.071%, compared with 2.14% for the last similar operation last month. It was the highest level since September 2008 when the fall of Lehman Brothers sparked a worldwide crisis.
Spain also paid higher borrowing rates to raise €3.225 billion in new short-term debt, a sign of persistent tension over its sovereign debt outlook.
The sales demonstrated Italy's and Spain's capacity to finance their debt but at a relatively high cost, despite a major European Central Bank programme of buying Italian and Spanish government debt on the markets.
After weeks of political wrangling, the Italian government this month adopted a strict austerity plan aimed at restoring budget balance by 2013 and reduce a debt mountain of €1.9 trillion - equivalent to around 120% of output.
But Italy has struggled to restore investor confidence as the centre-right coalition has been riven by infighting and Prime Minister Silvio Berlusconi has been mired in legal troubles and an escalating prostitution scandal. Italy pays around €75 billion in interest on its debt every year.
Spain, meanwhile, has promised to reduce its annual public deficit from the equivalent of 9.2% of gross domestic product last year to 6% of GDP this year.
It is now scrambling to raise extra money in 2011 to meet those targets - telling firms to pay tax installments early, lowering state spending on medicines and stimulating new home purchases with a tax cut.
Each year of deficit pushes up overall debt, which grew to 65.2% of GDP as of June 30 from 57.2% a year earlier.
Earlier this month, the government passed a constitutional reform to limit future budget deficits and curb the accumulated debt, trying to prove its determination never to slide deep into the red again.
