Euro crisis shifts to Italy, but Berlusconi says he won't resign

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The Italian markets soared Monday on rumours that prime minister Silvio Berlusconi would offer his resignation, paving the way for a new technocrat government that would ram through austerity programs.

As the rumours, later denied, raced through government offices and the markets, the Milan bourse rose 2 per cent, defying the downward trend that hit all other key European indices as the debt crisis hit Rome like a bomb.

In the early afternoon, central European time, Mr. Berlusconi used his Facebook page to try to kill the talk that he was on his way out. "The rumours of my resignation are groundless," he said.

Italian bond yields spiked to a new high Monday morning, reaching crisis levels, a day ahead of a parliamentary vote that could end Mr. Berlusconi's premiership.

The rising Italian yields came as Greek prime minister George Papandreou agreed to step down to make way for a national unity government, one that would secure the €130-billion bailout package approved at the last European Union summit and spare the country from bankruptcy. The identity of his replacement was still a matter of speculation early Monday afternoon.

The soaring Italian yields highlight Rome's dubious status as the new centre of the euro zone's debt crisis. The formation of a new government in Athens is viewed as a positive move by the investors. They have the opposite view about the political chaos in Rome, which will threaten the government's austerity programs unless confidence in the government is restored.

Yield's on benchmark 10-year Italian bonds climbed 26 basis points to 6.63 per cent Monday morning, putting them firmly in the danger zone (100 basis points equals one percentage point). Greece, Ireland and Portugal each required bailouts within months of their bond yields surpassing 7 per cent.

Another gauge of stress is the spread between Italian bond yields and those of German bunds, considered the safest debt in Europe. That spread is now 480 basis points.

The turmoil in Greece and Italy has turned economists bearish on European and global economic recovery. In a note published Monday, economists at Société Générale said that "The persistence of this extremely high level of financial stress is the trigger for the downgrade to our global economic outlook and now see recession in the euro area."

Société Générale said it 2012 forecast is for zero growth in the 17-country euro zone (which excludes Britain), down from the 2011 forecast of 1.7-per-cent growth in gross domestic product. The French bank expects the Italian economy to contract by 0.7 per cent in 2012 and remain in recession the following year.

According to Bloomberg data, Italy's 10-year bonds breached the 6-per-cent level on Oct. 28. The bonds of the trio of bailed out countries had average yields above 6 per cent for a month before reaching 6.5 per cent. After that, it took an average of 16 days for yields to surpass 7 per cent, Bloomberg said.

In a worrying sign, Italian bonds yields have been rising even though the European Central Bank, now led by former Bank of Italy boss Mario Draghi, has been buying Italian bonds in the secondary market in an effort to reduce their yields. The ECB starting the purchase program in August.

While Italy has a sophisticated and liquid bond market -- the world's third largest -- the government faces a formidable debt rollover schedule; it must refinance more than €300-billion of bonds next year. As the interest rate demanded by investors rises, so does the financial pressure on the Italian treasury. Higher financing costs will have to be offset by spending cuts, which could easily intensify the recession and raise unemployment, as they have in Greece.

Mr. Berlusconi, the winner of three elections since the 1990s, was humiliated at last week's Group of 20 summit in Cannes when he was essentially ordered to "invite" the International Monetary Fund to monitor the progress of the prime minister's promised austerity measures. IMF managing director Christine Lagarde said an IMF team would arrive in Rome this month and that she would meet Mr. Berlusconi.

Mr. Berlusconi's government heads into a crucial parliamentary vote on Tuesday to rubberstamp its 2010 budget report. A series of defections within his ruling coalition threaten to turn the vote against him, though over the weekend he insisted he had enough support to scrape through. He has vowed to remain prime minister until is mandate ends in 2013.

The centre-left opposition parties dismissed Mr. Berlusconi's statement that he still controlled a majority and promised a motion of no-confidence that would destroy the government even if it survives Tuesday's vote. Italian newspapers have estimated the number of rebels at between 20 and 40. Numbers that high would certainly topple the government, though Mr. Berlusconi, 75, has proved a remarkable survivor. He has survived more than 50 confidence votes in the last three years.

In Athens, several reports said that Mr. Papandreou will step aside in favour of Lucas Papademos, 65, a former ECB vice president. He is said to be the compromise choice between Mr. Papandreou's PASOK socialist party and the opposition New Democracy party, led by Antonis Samaras.

In Brussels, euro zone finance ministers are meeting to discuss extending further bailout loans to Athens, which is desperately short of cash. If a bailout installment worth €8-billion is not released shortly, the government faces shutdown within weeks.

European markets, save Milan, sank Monday. By early afternoon, local time, the FTSE-100 index was down about half a point; it had been down more than 1.5 per cent. and the euro had lost about 0.60 per cent against the dollar.