Italian bond yields soar further

The cost of Italian government borrowing rose to yet new euro-era record highs, as bond markets showed they are becoming increasingly edgy about whether Europe will find a solution to its debt crisis.

At the same time, recent increases in Belgium’s borrowing costs led rating agency Standard & Poor’s to cut that country’s credit rating one notch to AA, the third-highest investment grade, with a negative outlook.

In an auction Friday, the country had to pay an average yield of 7.814 per cent to raise $2.8 billion in two-year bills. In the previous auction in October, it paid 4.628 per cent.

And it will pay 6.504 per cent on $11.2 billion in six-month bills, nearly double the 3.535 per cent rate in October.

News of the auction result pushed rates for Italy’s ten-year bonds already trading in the markets to a yield 0.34 percentage points higher, at 7.30 per cent, above the seven per cent threshold that forced other nations into bailouts.

S&P predicts more bank bailouts in Belgium

In its downgrade of Belgium, S&P cited its need to backstop banks and a slowing economy as impeding the ability to pare its debt.

"Renewed funding and market risk pressures are increasing the likelihood that the Belgian financial sector will require more sovereign support," S&P said in a release.

Belgium agreed earlier to buy Dexia’s Belgian bank unit and to provide a guarantee on some of the lender’s liabilities for 10 years.

S&P's move came the same day as Moody’s downgraded Hungary’s government bonds to junk status — meaning they are too risky for investors such as pension funds — from Baa3 to Ba1 with a negative outlook.

Hungary is not a member of the eurozone, but trades with many of its members.

Bond investors are demanding a rate that’s high enough to justify lending to an economy — the eurozone’s third largest — that is too big for Europe and the International Monetary Fund to bail out, as it already has for Greece, Portugal and Ireland.

'Monti has failed so far to impress bond markets he has the power and authority to do what is required.'  —Louise Cooper, markets analyst at BGC Partners

Rising rates threaten to create a potentially devastating spiral because Italy is so heavily indebted that it must keep borrowing. Next year alone it must refinance $314 billion.

The higher rates also demonstrate that investors remain dubious about the ability of Italy’s new government under prime minister Mario Monti can do much to pare down its $2.7 trillion debt and are likely to fuel calls for the European Central Bank to use its firepower to cool down a debt crisis that's rapidly getting worse.

Monti has promised to move quickly to cut Italy's debt, but has spent much of his first week in office meeting with European Union officials and the leaders of France and Germany laying out his plans.

"Mario Monti has failed so far to impress bond markets he has the power and authority to do what is required," said Louise Cooper, markets analyst at BGC Partners. "I don't rate his chances either."

Italy’s poor auction results followed a failed sale on Wednesday by Germany — the region’s strongest economy and the main funder of eurozone bailouts — when it failed to raise all the money it sought, its worst auction result in decades.

Spain, too, has seen borrowing rates rise sharply higher even after a landslide election victory for the conservative Popular Party, which has made getting Spain's borrowing levels down its top priority.