The poor auction in Rome may be a warning sign that EU leaders offered too little to restore confidence at their Brussels summit two weeks ago.

German Chancellor Angela Merkel vetoed the creation of eurobonds or any serious move towards fiscal union, and shot down calls for an increase in the eurozone's €440bn emergency loan fund. The ECB has so far refused to step in to the breach with overwhelming action.

Willem Buiter, Citigroup's chief economist, said the response had been "woefully inadequate", raising the risk of fresh bank failures and a wave of sovereign defaults next year. He said the EU authorities may need a mix of measures worth up to €2 trillion to stop the rot.

Italy avoided the sort of property bubble seen in Spain or Ireland and has kept a tight rein on public spending under finance minister Giulio Tremonti. However, the rise in yields looks ominously like the pattern seen in Greece, Ireland, Portugal and Spain when they first began to lose easy access to the capital markets.

Neil Mellor, currency strategist at the Bank of New York Mellon, said big institutional investors have been pulling funds out of Italy and rotating into German debt on a large scale. "Our flow data shows that the trend has been just as concerted out of Italian debt as it has been out of Irish or Greek debt. Italy should be able to weather 2011 in good shape but the government's debt dynamics are very poor," he said.

Italy is too big to be rescued by a diminishing group of creditor states in the EMU core, should it ever need help. Public debt will creep up to 120pc of GDP next year – or over €1.9 trillion – a level widely seen as the outer limit of debt sustainability.

The country's trump card is a high savings rate and low private debt. Total debt is 245pc of GDP, below the eurozone average, and much lower than in Spain, Britain, the US or Japan. This may be the relevant indicator for an economy as a whole.

However, low private debt may equally reflect deep pessimism in a country where growth has been glacial for a decade, productivity has fallen since 1995, and global export share is in steep decline.

By Ambrose Evans-Pritchard, International Business Editor

Source >  Telegraph