MILAN/LONDON (Reuters) ? Italy's borrowing costs soared at a closely watched bond auction on Thursday as investors worried by the euro zone debt crisis and an impasse over the U.S. debt ceiling exacted a high risk premium.
The 8 billion euro ($11.4 billion) auction was conducted in volatile markets made more feverish by rumors, denied by Italian politicians, that Economy Minister Giulio Tremonti was preparing to resign.
The pressure on Italian stocks and bonds reflected both concern about Rome's ability to cut its sovereign debt -- second only to Greece's in Europe at 120 percent of annual output -- and doubts over whether last week's summit of euro zone leaders found a durable solution to the Greek debt crisis.
Criticism of the latest euro zone bailout plan for Athens has surfaced at the International Monetary Fund, as well as among European economists and market analysts, who say it does too little to reduce Greece's 340 billion euro debt.
A Reuters poll of 55 economists showed a majority felt that while the rescue package was a step in the right direction, it was not a turning point from which the crisis would be resolved.
Cyprus may be next in line for a bailout after its cabinet resigned on Thursday over a fatal munitions blast that destroyed the island's main power plant and compounded its economic problems, which include heavy exposure to Greek debt.
Italian yields at the bond auction jumped to 5.77 percent on 10-year paper, the highest since February 2000, and to 4.80 percent on three-year debt, the highest since July 2008.
"You can argue that they were able to place bonds in the market, but the trend in yields is starting to become really impressive," said Alessandro Giansanti, a strategist at ING in Amsterdam.
"They can't afford this kind of increase every month."
TREMONTI
Tremonti, long viewed as the guarantor of fiscal prudence in Prime Minister Silvio Berlusconi's fractious government, is under pressure over his use of a Rome apartment belonging to an aide under investigation for alleged corruption.
Umberto Bossi, head of the Northern League, part of Italy's governing coalition, dismissed rumors that Tremonti could lose his job, saying the affair was "nothing very serious." But the economy minister faces growing pressure from the opposition and media to explain himself, while his relations with Berlusconi have been strained for months.
Tremonti made a joke of the rumors that he might quit over the apartment issue, telling a news conference on Thursday: "I've resigned...as a tenant." He did not comment directly.
At one stage on Thursday, the secondary market yield on 10-year Italian government bonds jumped to 5.99 percent, near peaks hit during the height of bond market panic shortly before the euro zone summit. It later fell back to 5.84 percent, up only 7 basis points on the day, as fears over Tremonti and the threat of a U.S. debt default partially eased.
The rise in Italy's borrowing costs may put in doubt its contribution to the next tranche of aid for Athens in the current Greek bailout plan, to which Rome signed up last year, euro zone officials told Reuters.
In a conference call of euro zone finance officials on Thursday, during which the next tranche of emergency loans for Greece was discussed, Italy said it might have to use a "step-out" option in September if its own financing costs rose higher than those on the Greek loans.
"They have not decided one way or another," said one euro zone source familiar with the situation.
IMF CONCERN
Euro zone leaders agreed last week that their bailout fund, the European Financial Stability Facility, would in future be empowered to buy bonds in the secondary market and give states in difficulty precautionary credit lines.
But that will only take effect once new EFSF rules have been approved by national parliaments, a time-consuming and potentially difficult process. Italy's Treasury Director-General Vittorio Grilli said on Thursday he hoped the EFSF would gain its new powers by the end of 2011; in the meantime, euro zone states will remain vulnerable in bond markets.
An IMF source said there was growing concern among non-European members of the global lender's board about the Fund's exposure to Greece and the euro zone.
"There is a feeling on the board that we are in the same boat as the Europeans but we don't have much power to take decisions...We are linked to the errors of the Europeans," said the source, who spoke on condition of anonymity because of the sensitivity of the matter.
"The issue today is not so much the mistakes of Greece but what is happening with the Europeans. Some people are getting more uncomfortable than before."
Euro zone leaders' second bailout plan for Greece includes 109 billion euros in official funding for Athens, on top of 110 billion euros from a first bailout scheme launched in May last year. The IMF has agreed to contribute about a third of past euro zone bailouts, but it is unclear how much it will be willing to provide this time.
The Financial Times quoted the Brazilian and Indian members of the IMF board as warning against pouring further large sums into another Greek bailout with uncertain prospects. Brazilian director Paulo Nogueira Batista was quoted as saying the austerity imposed on Athens was too tough while Greece's private creditors were given too easy a time.
The new bailout includes money to be raised by selling Greek government assets. Greek Finance Minister Evangelos Venizelos appeared to backtrack on Thursday on plans to sell the government's stake in gaming monopoly OPAP said on Thursday that an expected loss at its Greek unit Emporiki and its participation in the rescue would force it to take a second-quarter provision of up to 850 million euros.
Investors worry that if the second rescue of Greece fails, European banks will have to accept bigger losses on their Greek debt holdings, as well as losses on bonds in Ireland and Portugal, which are also receiving bailouts.
Market valuations of euro zone bank shares have fallen this year close to levels hit during the global credit crisis of 2008-2009, in terms of both book value and projected earnings for the next 12 months, Thomson Reuters data shows.
(Additional reporting by Harry Papachristou in Athens, Daniel Flynn in Paris, Andy Bruce and William James in London and Jan Strupczewski in Brussels; Writing by Paul Taylor; Editing by Andrew Torchia)
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