Euro zone ministers threw a lifeline to Greece tonight as they scrambled to prevent financial chaos from spreading further.
Euro zone ministers met in Brussels in a bid ramp up the firepower of the EU rescue fund after Italy's borrowing costs hit a euro lifetime high of nearly 8 per cent.
The monthly meeting of 17 nations was dominated by attempts to keep Greece afloat and find enough money to coat a veneer of credibility over Europe's rescue fund. It came on the third day in a row that Italy has taken a beating in the bond markets, with investors growing increasingly wary of the country's chances of avoiding default.
The finance ministers approved the next instalment of the Greece's bailout loan - €8 billion. Without that money, Greece would have run out of cash before Christmas, unable to pay employees or provide services.
The instalment is part of a €110 billion bailout from euro zone nations and the International Monetary Fund that Greece has been dependent on since May 2010.
The new cash came after the EU demanded, and received, letters from top Greek political leaders pledging their support for tough new austerity measures.
However, in the latest sign of trouble, Italy was forced to pay an excruciatingly high interest rate on an auction of three-year debt. Demand was strong, but the 7.89 per cent rate was nearly three percentage points higher than last month, an enormous increase.
Italy has had preliminary discussions with the International Monetary Fund about financial support to cope with the euro zone's debt crisis, possibly co-funded by national European central banks, but no decision has been taken, several sources said.
New Italian prime minister Mario Monti briefed euro zone finance ministers on his fiscal plans today, but the sources said no formal request for IMF assistance was expected before he presents his budget to the cabinet on December 5th.
Italy has a €1.9 trillion debt pile - equivalent to 120 per cent of national output - and needs to refinance some €340 billion of maturing debt next year with big redemptions starting in late January. It has promised to balance its budget in 2013 but today's auction suggested it will struggle to keep borrowing costs under control without international help.
Two years into Europe's sovereign debt crisis, investors are fleeing the euro zone bond market, European banks are dumping government debt, deposits are draining from south European banks and a looming recession is aggravating the pain, fuelling doubts about the survival of the single currency.
Italy had to offer a record 7.89 per cent yield to sell three-year bonds, a stunning leap from the 4.93 per cent it paid in late October, and 7.56 per cent for 10-year bonds, compared with 6.06 per cent at that time.
The yields were above levels at which Greece, Ireland and Portugal applied for international bailouts, but European stocks and bonds rallied in apparent relief at the strong demand, with the maximum €7.5 billion sold.
The euro had earlier dipped on a report in business daily La Tribune that ratings agency Standard & Poor's would lower its outlook on France's AAA credit rating to negative within 10 days, dealing a potential body blow to the euro zone's ability to rescue heavily indebted countries.
Ministers said the International Monetary Fund may have to provide more help, possibly bolstered with more European money.
"We will have to look at the IMF which can also make available additional funds for the emergency fund. I think countries in Europe and outside of Europe should be prepared to give more money to the IMF," Dutch finance minister Jan Kees de Jager told reporters on his way into the talks.
The ministers are discussing leveraging the European Financial Stability Fund (EFSF) so it can help Italy or Spain should they need aid, although worsening market conditions mean it is likely to fall short of the original €1 trillion target.
The report about France's credit rating came at a delicate time. Paris is the second largest guarantor of the EFSF bailout fund, and one of only six AAA states in the euro zone. S&P declined comment.
Officials said the leveraging mechanisms could become operational in January, but that may be too late.
"We have talked about leverage though private money, but it would be two or two and a half times an increase so not sufficient and we have to look for other solutions to compliment the EFSF and that in my mind will be the IMF," Mr de Jager said.
With Germany opposed to the idea of the European Central Bank providing liquidity to the EFSF or acting as a lender of last resort, the euro zone needs a way of calming markets and the ECB shows no sign yet of responding to widespread calls to massively increase its bond-buying.
One option EU sources said is being is explored is for euro system central banks to lend to the IMF to aid Italy and Spain.
"We will discuss with the ECB. The ECB is an independent institution, so we will put on the table some proposals and after that it is for the ECB to take the decision," Belgian finance minister Didier Reynders told reporters.
The ECB failed for the first time since May to fully offset €203.5 billion in euro zone government bond purchases, adding to fears that the debt crisis is ratcheting up stress on the bloc's banking sector.
A Reuters poll of economists showed a 40 per cent chance of the ECB stepping up bond-buying with freshly created money within six months, something it has opposed.
The poll forecast a 60 per cent chance of an ECB rate cut to 1 per cent next week and a big majority of economists said they expect the central bank to announce new long-term liquidity tenders to help keep banks afloat at its December 8th meeting.
Berlin has pinned its efforts on a drive for closer fiscal integration among euro zone members.
German chancellor Angela Merkel will not make a deal at a December 9th European Union summit to stop resisting joint issuance of euro zone bonds in exchange for progress on strengthening fiscal rules, German MPs quoted her as saying. She told a closed-doors meeting Europe was "a long way from euro bonds", suggesting they may not be ruled out forever.
For now, Germany and France are pressing for coercive powers to reject euro zone members' budgets that breach EU rules, alarming some smaller nations who fear the plans by-pass mechanisms for ensuring equal treatment.
Berlin and Paris aim to outline proposals for a fiscal union before the EU summit that is increasingly seen by investors as possibly the last chance to avert a breakdown of the single currency area.
Poland's foreign minister Radoslaw Sikorski made an appeal for Germany to show more leadership in the crisis.
"You know full well that nobody else can do it," he said in a speech in Berlin yesterday evening.
"I will probably be the first Polish foreign minister in history to say so, but here it is: I fear German power less than I am beginning to fear German inactivity. You have become Europe's indispensable nation."
Reuters