Italian debt continues to sink

Italy sold 6-month debt today for a yield of 6.504%, almost double the 3.5% obtained a month ago at the auction of October 26. This is the highest price paid since August 1997 by Italy, the world’s fourth biggest borrower.

“So in the matter of three weeks, Italy’s credit worthiness has sunk to desperate levels,” says Kathleen Brooks of Gain Capital in a note.

Reported purchases by the ECB of Italian debt on the secondaries market seem to have failed in their aim of supporting the debt auction. Bond yields have surged, with 10-year yields at 7.32%. Italy’s bond curve is fully inverted, with 2-year bonds yielding 46 basis points more than 10-year notes, at 7.82%.

The yields demonstrate the extreme stress in Italy’s financial system, said Brooks. “This is clearly an unsustainable situation and Italy won’t be able to afford to sell debt at this level,” she says. The next bond auctions are on Monday and Tuesday next week, with an auction of €22bn of debt coming up in December.

The yield surge is adding to the already considerable pressure on Germany to allow the ECB to step in. Germany fears that such a measure would result in increased yields for Germany, already rising thanks to their own only partially successful bond auction this week.

<>As Germany hesitates, says Brooks, so the stresses are building. Inter-bank financing costs are approaching 2008 levels. European banks are finding increasing difficulty to obtain dollars to obtain to meet dollar-based liabilities. “This is turning nastier by the minute and the result will be a credit crunch on the scale of 2008, and a recession in the world’s largest economic bloc,” she said.

The Spanish Treasury today has cancelled a planned 3-year auction next week. This week it paid 5.11% on 3-month notes, more than twice the previous sale and higher than Greece pays.

The news came as Mario Monti, Italy’s new prime minister, met German Chancellor Angela Merkel and French President Nicholas Sarkozy in Strasbourg to discuss greater fiscal co-ordination.

Olli Rehn, EU commissioner for economic affairs, speaking at the Italian Parliament, said Italy was facing “formidable challenges” and that the recovery had stalled. He said new fiscal measures would take effect in Italy on December 13. The measures include automatic sanctions for any infractions. Rehn added that on December 9 President of the EU Council Herman van Rompuy and Eurogroup chairman Jean-Claude Juncker would be presenting new EU treaty revisions.

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