Worries about Europe's debt troubles roared back Tuesday with a vengeance, as investors dumped bonds of Italy and Spain and pushed yields to dangerously high levels.
Analysts are concerned that Italy, the euro zone's second-largest debtor nation, and Spain may struggle to handle their debts as their economies sputter and investors demand a steep premium to lend them more money. Those concerns helped push the gap in yields between Italian government bonds and safe-haven German bonds to a new high of nearly four percentage points Tuesday.
Italian Finance Minister Giulio Tremonti huddled Tuesday with officials from the Bank of Italy and other regulators in an emergency meeting to discuss rising and potentially punishing debt-service costs.
Jean-Claude Juncker, who chairs the Eurogroup of euro zone finance ministers, said he would meet Mr. Tremonti Wednesday in Luxembourg to talk about deteriorating financial conditions in the currency bloc.
And in Spain, Prime Minister Jose Luis Rodriguez Zapatero delayed a planned vacation as the country's borrowing costs there neared 7 per cent - the threshold that triggered earlier bailouts of Greece, Portugal and Ireland.
The yield on 10-year Italian bonds briefly reached 6.25 per cent Tuesday, before falling back to 6.14 per cent. The comparable rate for German bonds is 2.4 per cent.
Global financial markets are in upheaval despite a weekend deal to resolve the showdown in Congress over the U.S. debt ceiling and the recent bailout of Greece.
The message inherent in the renewed spike in bond yields in Italy and Spain is that the risk of contagion still haunts Europe, explained David Rosenberg, chief economist and strategist at Gluskin Sheff in Toronto.
But unlike Greece, Italy and Spain may be too big to fail.
"The closer those yields go to 7 per cent, the more investors begin to discount bailouts for these two countries," Mr. Rosenberg pointed out in a research note. The two economies, he added, are "far too large to save."
Canadian Finance Minister Jim Flaherty echoed the concern, saying Europe needs to focus on a broader solution to bolster the euro zone.
"Our concern in Europe - and we've encouraged the Europeans to act in this direction - is to create a European solution to these issues, that if one addresses these issues country by country it's difficult to get ahead of the potential crisis," Mr. Flaherty told reporters in Mississauga, Ont.
At the same time, Mr. Flaherty applauded Italy for making all the right moves to manage its finances.
"The steps that have been taken by the government of Italy, by Finance Minister (Giulio) Tremonti, to create some government austerity in Italy, and I think that that is moving in the right direction," he said.
But economist Edward Harrison of Global Macro Advisors worried that the number of financially healthy euro zone countries able to backstop weaker neighbours is dwindling. There are just five countries - Germany, France, Italy, Spain and the Netherlands - with the means to support a stability fund, he said, and two of those are now in debt trouble.
"The Europeans can't catch a break," he said.
Last week, Moody's Investors Service put Spain's double-A2 rating on review for a possible cut, citing "funding pressures" after a summit of the region's officials failed to convince investors they would halt the spread of the debt crisis after arranging a so-called selective default for Greece.
The euro zone and the International Monetary Fund earlier granted bailouts to Greece, Ireland and Portugal. Tiny Cyprus may be next in line due to its banks' exposure to Greek debt, and the economic fallout from an explosion last month that destroyed its sole electrical power station.
Twice bailed-out Greece can look forward to rising living standards if it continues unpopular austerity and reform measures, including an end to civil service jobs for life, according to the Paris-based Organization for Economic Co-operation and Development said in an annual review of Greece's economy.
"The results are starting to show, with rising exports and improved competitiveness," OECD Secretary-General Angel Gurria said. "The program can succeed. But success will depend on continued reforms and thorough implementation. … There is a long and hard road ahead."
With files from Reuters