Italy's cost of borrowing has touched a new record, a day after Prime Minister Silvio Berlusconi said he would resign once budget reforms were passed.
The yield on 10-year government bonds reached more than 7%, the highest since the euro was founded in 1999.Investors fear that Italy could become the next victim of the debt crisis.
The 7% level is widely viewed as unsustainable and was the point at which Portugal, Greece and the Irish Republic were forced to seek a bailout.
In comparison, Germany's implied cost of borrowing for 10 years is 1.73%.
The BBC's business editor Robert Peston said: "No-one wants to lend to a country when that country would use the loan to pay the interest on previous loans - that's throwing good money after bad."
The debt was also pushed up as a clearing house asked for a larger deposit to trade Italian bonds - to cover the increased risk of non-payment.
Economic Affairs Commissioner Olli Rehn called the situation in Italy "very worrisome". A team from the European Union is due in Rome on Wednesday to begin monitoring how Italy plans to cut its soaring debt burden.
It is expected that Italy's parliament could approve a package of budget reforms by the end of the month, after the Italian president engages in consultations with the political groups on the way forward.
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“Start Quote
End QuoteWhen the implicit interest rate rises to that kind of level, investors know that a country with big debts can't afford to repay what it owes”
The euro also dropped to a one-month low against the dollar, down 2% to $1.3838.
AuctionLCH Clearnet, a clearing house for buying and settling debt, has asked for a larger margin, or deposit, for trading debt of the eurozone's third-biggest economy.
Rates on the 10-year bonds are currently the highest since June 1997, when Italy still had the lira.
They are even higher on one- and two-year Italian debt, meaning that it is considered even less likely that Italy will pay back what it owes immediately than in a decade's time.
One-year Italian debt is now yielding more than 8%. An auction of the debt is due to take place on Thursday.
The higher the yield - the implied cost of borrowing - goes for Italy, the more likely it is that the country's huge economy will need to be bailed out - something that the eurozone has been desperately trying to avoid.
Italy has to roll over more than 360bn euros (£309bn) of debt in 2012.
On Tuesday, Mr Berlusconi said that he planned to resign after failing to win an absolute majority in the lower house of parliament in a vote on the budget.
Concerns are spreading to other previously safe nations.
The gap, or spread, between French and German 10-year bonds reached a record high of 1.47 percentage points. France has proposed a round of reforms recently to prevent it from losing its highest AAA rating.
Shares fall
Stock markets in the US and Europe were sharply lower.
Economics editor Stephanie Flanders explains why Italy is such a problem
Financial stocks, which are heavily exposed to eurozone debt, led the decliners.
Allianz fell 6.6%, Deutsche Bank dropped 4.5% and Commerzbank declined 5.1%.
Shares in Mediaset, the media group controlled by Mr Berlusconi, fell almost 10%.
In France, BNP Paribas dropped 2.9% and Societe Generale dropped 4.6%.
On Tuesday, SocGen reported that quarterly profits had fallen by 31% because of a 60% write-off on its Greek loans.
Shares in HSBC and Barclays were also lower in London.
Greek concerns
Greece, which has been bailed out twice and is undergoing painful austerity cuts, also looks close to forming a new government.
The country has more than 340bn euros of debt - and fears over its default have spread to worries about the fiscal health of other eurozone nations.
In October, eurozone member countries agreed a plan to expand their rescue fund and have banks take larger losses on Greek debt.
The fallout over the deal led to Prime Minister George Papandreou resigning and a new government that will implement the terms of the deal.
The head of the Greek opposition has reportedly balked at eurozone demands for a written commitment to the fiscal targets and measures demanded by the country's lenders before they get the next tranche - worth 8bn euros - from the first bailout.
Without it, Greece will run out of money within weeks.
taken from http://www.bbc.co.uk/news/business-15652708
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