Political and economic crisis in Italy spurred fears of a split in the eurozone, with borrowing costs for Europe’s third-biggest economy near unsustainable levels and the bloc unable to afford a bailout.
The escalating crisis prompted European Commission President Jose Manuel Barroso to issue a stern warning of the dangers of splitting the zone. EU sources told reporters that French and German officials had held discussions on just such a move.
“There cannot be peace and prosperity in the North or in the West of Europe, if there is no peace and prosperity in the South or in the East,” Barroso said.
German Chancellor Angela Merkel weighed in with a call to arms. She said Europe’s plight was now so “unpleasant” that deep structural reforms were needed quickly, warning the rest of the world would not wait.
“That will mean more Europe, not less Europe,” she told a -conference in Berlin.
She called for changes in EU treaties after French President Nicolas Sarkozy advocated a two-speed Europe in which eurozone countries accelerate and deepen integration, while an expanding group outside the currency bloc stays more loosely connected — a signal that some members may have to quit the euro.
“It is time for a breakthrough to a new Europe,” Merkel said. “A community that says, regardless of what happens in the rest of the world, that it can never again change its ground rules, that community simply can’t survive.”
The European Central Bank, the only effective bulwark against market attacks, intervened to buy Italian bonds in large amounts, but remained reluctant to go further and Italy’s 10-year bond yields shot above 7 percent, a level widely deemed unsustainable, as investor confidence evaporated.
“Financial assistance is not in the cards,” one eurozone official said, adding that the bloc was not even considering extending a precautionary credit line to Rome.
Italy replaced Greece at the center of the crisis as Italian Prime Minister Silvio Berlusconi’s insistence on elections instead of an interim government threatened prolonged instability.
Having lost his majority in a parliamentary vote, Berlusconi confirmed he would resign after implementing economic reforms demanded by the EU, and said Italy must then hold an election in which he would not stand.
He said polls were not likely until February, leaving a three-month policy vacuum in which markets could create havoc.
Even with the exit of a man who came to symbolize scandal and empty promises, it will not be easy for Italy to convince markets it can cut its huge debt, liberalize the labor market, attack tax evasion and boost productivity.
Worries that the debt crisis could be infiltrating the core of the eurozone were reflected in the spread of 10-year French government bonds over their German equivalent, blowing out to a euro era high of about 140 basis points.
EU sources told reporters German and French officials had discussed plans for a radical overhaul of the EU that would involve establishing a more integrated and potentially smaller eurozone.
The discussions among policymakers in Paris, Berlin and Brussels raise the possibility of one or more countries leaving the zone, while the core pushes to deepen economic integration.
In a speech in Berlin, Barroso said Germany’s GDP could contract by 3 percent if the 17--member zone shrank and its economy would shed 1 million jobs.
“What is more, it would jeopardize the future prosperity of the next generation,” he said.
Barroso said any push toward deeper integration should not come at the price of new divisions among EU member states.
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