European Union flags are seen outside the European Commission headquarters in Brussels.YVES HERMAN/Reuters
France came under heavy fire on global markets on Tuesday reflecting fears that the euro zone's second biggest economy is being sucked into the debt crisis after a warning that Paris's inability to adapt should be "ringing alarm bells".
Nervous markets also showed concern about whether Italy's Mario Monti and new Greek leader Lucas Papademos, unelected European technocrats without a domestic political base, can impose tough austerity measures and economic reform.
European Central Bank president Mario Draghi has predicted the 17-nation currency bloc will be in a mild recession by the end of the year, a view underlined by data showing the economy barely grew in the third quarter and faces a sharp downturn.
"The risks of a technical recession have increased and we expect the economy in Germany to shrink at least in one quarter, most likely in the first quarter of next year," said economist Michael Schroeder of German economic research institute ZEW.
On the markets, Italy's 10-year bond yield rocketed back above 7 per cent, pushing its borrowing costs to a level widely seen as unsustainable in the long term, which helped trigger the fall of Silvio Berlusconi's government last week.
Spain's Treasury paid yields not seen since 1997 to sell 12- and 18-month treasury bills.
French 10-year bond yields have risen around 50 basis points in the last week, pushing the spread over safe haven German bonds to a euro era high of 173 basis points.
French banks are among the biggest holders of Italy's €1.8-trillion public debt pile.
The urgency of resolving the debt crisis was underscored by a think-tank report saying triple-A rated France should also be "ringing euro zone alarm bells" as it could not make rapid adjustments to its economy.
In New York, U.S. stock index futures fell sharply on Tuesday morning after the rise in European bond yields, the drop caused by fears in the United States that Europe's debt crisis was mushrooming into a wider systemic problem.
President Barack Obama's top economic adviser said the European debt crisis was the leading risk to the U.S. recovery.
"Clearly, Europe is a tremendous concern," Alan Krueger, chairman of the White House Council of Economic Advisers, said.
"It is important they act quickly, because it is a threat not only to Europe and the U.S., but the world as a whole."
With the survival of the 17-state currency zone in its current form now at risk, EU governments have until a summit on December 9 to come up with a bolder and more convincing strategy, involving some form of massive, visible financial backing.
The debt crisis is likely to make matters worse in the next months with nations such as Italy, Greece, Ireland, Portugal and Spain forced to adopt politically unpopular cuts to stop the bond market driving them towards default.
Economists say there is no visible growth strategy in place to counter those austerity measures.
After last week's disastrous week for the euro zone's third biggest economy, Italy's Monti appeared to win a key breakthrough on Tuesday when Angelino Alfano, secretary of Berlusconi's People of Freedom (PDL) party, emerged from the talks saying moves to form a government would succeed.
With the zone under intense scrutiny, Germany and France posted solid growth in the third quarter, statistics released on Tuesday showed, but euro zone nations on the front line of the debt crisis fared much worse and analysts expect bleaker times ahead in the core economies.
"The key point is that this is all history," said Jonathan Loynes, chief European economist at Capital Economics.
"Forward-looking indicators suggest that the euro-zone economy is likely to drop back into recession in the fourth quarter and beyond," he said.
The entire euro zone economy grew just 0.2 per cent in the third quarter from the second, lifted by France and Germany, but economists were resigned to the fact the bloc was almost certainly heading for a recession.
Stagnation in Spain, Belgium and a contraction in the Netherlands and Portugal appeared to signal that the worse was yet to come and a summer growth spurt was temporary.
Mr. Monti is racing to secure support from feuding politicians to allow his cabinet of experts to speed up reform of pensions, labour markets and business regulation needed to put Italy's finances on a sustainable footing.
Italy has to refinance some €200-billion ($273-billion U.S.) of bonds by the end of April, a daunting prospect
Expected to seek a confidence vote by Friday, Mr. Monti has said that he aimed to serve until scheduled elections in 2013, not just until reforms had been pushed through.
Far-reaching reforms are seen as crucial if Italy is to end years of stagnant growth, trim a debt mountain equal to 120 per cent of gross domestic product and avoid the sort of crisis that forced bailouts of Greece, Ireland and Portugal.
In Athens, Mr. Papademos said late on Monday that Greece had no choice but to stay in the euro zone, telling lawmakers reforms were the only solution.
But conservatives on whom Mr. Papademos must rely for support demanded pro-growth policies and rejected any more cuts, fuelling fears of a Greek default that may force Athens out of the currency group triggering a euro zone debt meltdown.
Austerity measures had deepened Greece's recession but reforms -- including widening the tax base and fighting rampant tax evasion -- could mitigate the problem, said Mr. Papademos, who oversaw Greece's entry to the euro zone in 2002.
But New Democracy leader Antonis Samaras said he would not vote for new austerity measures and he would not sign any pledge about new belt-tightening.
The European Commission issued a stark warning to Greece on Tuesday that it must provide written confirmation to its European partners of its commitment to reforms to bring down its debt, no matter who wins the next elections.
"The Eurogroup as a whole expects Greece, the Greek political forces, to provide a clear and unequivocal commitment to the agreement ... and we expect this in writing. It has to be a letter and signed," Commission spokesman on economic and monetary affairs Amadeu Altafaj told reporters.
Most Greeks hailed Mr. Papademos's appointment, but thousands of people angry at more than a year of austerity are expected to rally on Thursday, the anniversary of a 1973 student uprising that helped to bring down the colonels' junta of 1967-74.