The policy makers pledged to complete “soon” the Greek aid blueprint, without giving more details. The meeting in Brussels didn't discuss Italy, though the ministers were aware the country is now the “focus” of financial markets, Luxembourg's Jean-Claude Juncker said at a press conference late yesterday.

Acknowledging Contagion
“Europe needs to recognize it's no longer a crisis of small sovereigns in the euro area,” Jacques Cailloux, chief European economist at Royal Bank of Scotland Plc said in an interview yesterday with Maryam Nemazee on Bloomberg Television's “The Pulse” “It is becoming a euro-area wide crisis and European policy makers have struggled to accept that for some time.”

The yield on 10-year Italian bonds rose 7 basis points to 5.76 percent, after reaching 5.96 percent earlier, the highest since 1997. The yield premium investors demand to hold the debt over German bunds to a euro-era reached a euro-era record 348 basis points, before narrowing to 311.

Bill Auction
The jump in bond yields translated into a surge in the country's borrowing costs today, when Italy priced 6.75 billion euros of 1-year bills to yield 3.67 percent, compared with 2.147 percent at the previous sale a month ago. The Treasury is due to sell 5 billion euros of bonds on July 14.

Italy's bonds have suffered more than debt of Spain, considered the euro-region's next-weakest link after the three bailed-out countries. The premium to hold Spanish debt over Italian bonds narrowing to as low as 30 basis points, the least since November 2010.

Trading in shares of UniCredit SpA, Italy's biggest bank, had to be suspended limit down after the stock plunged more than 7 percent, pushing the benchmark FTSE MIB index down as much as 4.8 percent. UniCredit, one of the biggest holders of Italian bonds, pared losses and advanced 4.5 percent to 1.206 euros as of 11:40 a.m. in Milan. Even with the rebound, UniCredit has fallen by 22 percent this month, shedding about 9 billion euros in market value.

Tremonti Leaves
Italian Finance Minister Giulio Tremonti left the Brussels meeting early to return to Rome to prepare to present his 40 billion-euro budget-adjustment package to Parliament. The plan seeks to eliminate the deficit in 2014. Neither he nor Berlusconi has commented publicly on the Italian sell-off.

The bulk of the measures won't be taken until 2013, when general elections are due. Market turmoil has been stoked by investor concern about the plan's implementation and tensions over the cuts between Berlusconi and Tremonti, including speculation that the minister may resign.

“The recently announced fiscal adjustment profile is heavily back-loaded to 2013-2014, by which point the plan may be diluted. Besides, the general elections are scheduled for 2013, further threatening the plan's credibility,” Pillonca said. “The political situation remains fragile. The rift between Finance Minister Tremonti and Berlusconi reinforces the political uncertainty.”

The market sell-off spurred opposition leaders to offer quick passage of the plan, vowing to present few amendments that would slow a vote. Italy's Senate may approve the plan on July 14 with the Chamber of Deputies voting three days later, Anna Finocchiaro, head of the Senate delegation of the main opposition Democratic Party, told news agency Radiocor today.

'Disaster'
Italian bond yields are nearing “disaster,” according to Gary Jenkins, head of fixed-income at Evolution Securities Ltd. Greece, Ireland and Portugal all sought international assistance after their 10-year yields rose past 7 percent.

Italy has more than 500 billion euros of bonds maturing in the next three years. That's about twice as much as the 256 billion euros extended to Greece, Ireland and Portugal in their three-year aid programs.

At almost 120 percent of gross domestic product, Italy's debt is the EU's second largest by that measure after Greece. Its 1.8 trillion euros of borrowing in nominal terms is more than the combined debt of Greece, Spain, Portugal and Ireland.

Borrowing Costs
The surge in Italy's bond yields, if sustained, will increase financing cost, which the government estimates will total about 75 billion euros this year, or almost 5 percent of GDP. That figure is expected to rise to 85 billion euros by 2014.

Jefferies International Ltd. estimates that if the average interest rate on the debt rises to 6 percent over that period rather than the 5 percent forecast, financing costs will jump by another 35 billion euros.

Average financing costs of 5.5 percent means Italy would need a primary surplus of at least 3 percent to stabilize debt at around 120 percent of GDP, a level Italy won't reach until 2015, Pillonca estimates.

Until this month, Italy had avoided the worst of the debt crisis fallout. Tremonti's fiscal rigor helped trim the budget deficit to 4.6 percent of GDP last year, less than half the shortfalls in Greece, Spain and Ireland. The country dodged the real-estate bubble that devastated the Irish and Spanish economies. More than half its bonds are held domestically, which with the low level of household debt, was seen as underpinning demand and shielding Italy from some of the turbulence in international markets.

'Better Shape'
“Italy is still in better shape,” Michael Spence, a Nobel-winning economist, told Ken Prewitt and Tom Keene on Bloomberg Radio's “Bloomberg Surveillance” yesterday. “It has a high amount of debt, but it has a high savings in the private sector, and frankly I think it can manage its way through this unless there is a huge attack on the euro and risks spreads go way up.”

Confidence in Italy has eroded after both Moody's and S&P in the past month said they were reviewing their ratings. The country's anemic growth will make it difficult to tame the debt even if the government achieves its goal of balancing the budget in 2014, they said. Moody's last cut Italy's rating in 1993. S&P has an A+ rating and last cut in October 2006.

Italy's economy expanded an average 0.2 percent annually from 2001 to 2010, compared with 1.1 percent in the euro area. Growth was 0.1 percent in the first quarter, a fraction of the 0.8 percent for the euro region.

Bloomberg News

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