Italy's cost of borrowing hit new record levels on bond markets today, with the yield on 10-year bonds surging above 7%.
This is despite last night's announcement that Prime Minister Silvio Berlusconi plans to stand down.
The interest rate demanded by investors to lend money to Italy for ten years reached just over 7.45% this morning before falling to around 7.248% this evening. Rates above 7% are seen by many economists as unsustainable.
Clearing house LCH.Clearnet raised the initial margin call applied to Italian debt by between 3.5 and 5 percentage points. This makes it more expensive to trade in Italian bonds. The Italian stock market, which had initially opened slightly higher, fell sharply as borrowing costs rose. It closed 3.8% lower this evening.
Bond traders said the European Central Bank, which has been buying Italian bonds since August to keep yields down, stepped in again this morning.
Italy has been the focus of the market anxiety in recent days, with investors increasingly worried that political turmoil is hindering efforts to stop the third biggest euro zone country becoming engulfed by the crisis
Italy's debt is equivalent to 120% of economic output and it is too big to be bailed out with currently available resources.
Berlusconi said last night he would resign after enacting economic reforms demanded by the EU. He was seen by many as an obstacle to economic reform and the sell-off in Italian bonds accelerated earlier this year when he hesitated to pass the austerity steps proposed by his finance minister.
But even when Berlusconi goes, analysts saw no guarantee that reforms to cut debt and boost growth will be quickly implemented.
Italy to adopt reforms within days - President
Italy's parliament will adopt a package of economic reforms promised to the European Union "within days" and Prime Minister Silvio Berlusconi will then resign, the head of state said today.
"There is no uncertainty on the prime minister's decision to hand in his resignation" following approval of the measures, President Giorgio Napolitano said in a statement, adding that this would happen "within days."
He said Italy's borrowing rates had reached "alarming" levels.
Following Berlusconi's resignation, Napolitano said he would "immediately and quickly" launch talks on forming a new government.
"Within a short space of time either a new government is formed that can take future decisions with the confidence of parliament or parliament will be dissolved to launch immediately an election campaign," he said.
"Any fear that Italy could see prolonged period of political and parliamentary inactivity are completely unfounded since it is in any case possible at any moment to adopt emergency measures if needed," he added.
The euro zone should remain intact, European Council President Herman Van Rompuy said today, amid an escalating debt crisis in the 17-nation's bloc.
"The aim is to keep the euro zone together, with all the 17 participants on board," he said during a visit to Switzerland, where he meet Swiss Foreign Minister Micheline Calmy-Rey.
