11/09/2011 06:03 EST | Updated 01/09/2012 05:12 EST

Markets' Berlusconi rally proves short-lived as Italian borrowing rates again spike higher

LONDON - Uncertainty over who will lead Italy through the debt crisis once Premier Silvio Berlusconi resigns slammed European stocks and bonds on Wednesday, pushing Rome's borrowing rates to worrying new highs.

Tuesday's news that Berlusconi had finally bowed to pressure and would resign once new austerity measures are passed had helped markets in the U.S. and Asia higher. Berlusconi had been perceived as part of the problem in the political deadlock gripping Italy.

That buying persisted for a while in Europe, but sentiment quickly soured again as traders worried about Italy's uncertain future.

Italy's ten-year yield jumped above the 7 per cent rate widely considered to be unsustainable in the long-run. When Greece, Ireland and Portugal saw their ten-year borrowing rates rise above 7 per cent, the markets concluded they had to be bailed out.

By late morning, the yield was trading at 7.35 per cent, up 0.77 of a percentage point from the previous day.

What happens in Italy is crucial to the eurozone's survival. With debts of around €1.9 trillion ($2.6 trillion), Italy's debts are considered far too big for Europe to bail out.

Higher rates would make it more difficult and expensive for Italy to roll over its debts. The country has over €300 billion ($412 billion) to raise in 2012 alone.

The worry appears to be that even without Berlusconi at the helm, Italy faces a period of political deadlock.

The next government will likely face the same pressures as Berlusconi — to enact quick reforms to shore up Italy's defences against Europe's raging debt crisis.

"The positive impact of Berlusconi's promised resignation is being diluted by a lack of clarity on where we go from there," said Adam Cole, an analyst at RBC Capital Markets. "The possibilities range from a technocrat government — most market positive — to new elections — most negative."

In Europe, the main Milan stock index was down 4.2 per cent while Germany's DAX was down 1.8 per cent at 5,855 and the CAC-40 in France fell 1.9 per cent to 33,085. The FTSE 100 index of leading British shares was 1.2 per cent lower at 5,500.

The euro also fell sharply, trading 1.1 per cent lower at $1.3673.

Wall Street was poised for a retreat, too — Dow futures were down 1.3 per cent at 11,972 while the broader Standard & Poor's 500 futures fell 1.7 per cent to 1,252.

As well as keeping one eye on developments in Rome, investors are waiting to hear who will be the new prime minister in Greece.

On Tuesday, Socialist Cabinet members issued their resignations, paving the way for the creation of a new government, which is only expected to last until February.

Former European Central Bank vice-president Lucas Papademos was the early favourite to become the interim prime minister, but it was unclear whether he remained in the running.

The new government will be tasked to secure the country's new €130 billion ($179 billion) European rescue package and then get it through parliament. That approval will allow the release of a €8 billion ($11 billion) loan installment, without which Greece will go bankrupt before Christmas, potentially wrecking Europe's banking system and sending the global economy back into recession.

The political crisis erupted last week, when Premier George Papandreou said he would put the new European rescue package to a referendum. Other eurozone nations were horrified by the delay, markets around the world tanked and Greece's international creditors froze the payment of the next bailout.

Earlier in Asia, sentiment had been boosted by the Berlusconi pledge, with Japan's Nikkei 225 index closing 1.2 per cent higher at 8,755.44. South Korea's Kospi added 0.2 per cent to 1,907.53 and Hong Kong's Hang Seng jumped 1.7 per cent to 20,014.43.

There was also some cheer from the news that China's stubbornly-high inflation fell in October as rapid rises in food costs eased. The decline was seen positively by investors as it gives Beijing more room to stimulate China's economy.

Mainland China's Shanghai Composite Index gained 0.8 per cent to 2,524.92 and the smaller Shenzhen Composite Index rose 1.6 per cent to 1,071.04.

Oil prices tracked equities lower — benchmark crude was down 96 cents at $95.84 a barrel in electronic trading on the New York Mercantile Exchange.


Pamela Sampson in Bangkok contributed to this report.