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Brussels/Milan - Eurozone ministers agreed to ramp up the firepower of their rescue fund, but couldn't say by how much, and may turn to the IMF for more help as a stunning leap in Italy's borrowing costs pushed the region closer to financial disaster.
Two years into Europe's sovereign debt crisis, investors are fleeing the eurozone bond market, European banks are dumping government debt, south European banks are bleeding deposits and a recession looms, fuelling doubts about the survival of the single currency.
"The situation in Europe and the world has significantly worsened over the past few weeks. Market stress has intensified," said Christian Noyer, France's central bank governor and a governing council member of the European Central Bank (ECB).
"We are now looking at a true financial crisis - that is a broad-based disruption in financial markets," he said at a conference in Singapore on Wednesday.
The Eurogroup, which brings together finance ministers from the 17 eurozone members, agreed on Tuesday to a detailed plan to insure the first 20% - 30% of new bond issues for countries having funding difficulties and to create co-investment funds to attract foreign investors to buy eurozone government bonds.
Both schemes would be operational by January with about €250bn from the eurozone's European Financial Stability Facility (EFSF) bailout fund available to leverage after funding a second rescue programme for Greece, Eurogroup chairperson Jean-Claude Juncker said.
The aim was for the International Monetary Fund (IMF) to match and support the new firepower of the EFSF, Juncker told a news conference.
"We also agreed to rapidly explore an increase of the resources of the IMF through bilateral loans, following the mandate from the G20 Cannes summit, so that the IMF could adequately match the new firepower of the EFSF and cooperate even more closely," he said.
But with China and other major sovereign funds cautious about investing more in eurozone debt, EFSF chief Klaus Regling said he did not expect investors to commit major amounts to the leveraging options in the next days or weeks.
He said he couldn't put a figure on the final size of the leveraged fund.
"It is really not possible to give one number for leveraging because it is a process. We will not give out a hundred billion next month, we will need money as we go along," he said.
Most analysts agree the eurozone needs to adopt profound measures to combat a crisis that is sucking in some of the bloc's biggest economies.
Italy, the eurozone's third-biggest economy, had to offer a 7.89% yield to sell 3-year bonds, a euro lifetime high and a staggering jump from 4.93% paid in October. Yields on 10-year debt rose to 7.56% from 6.06%.
The European Commission's top economic official Olli Rehn said Prime Minister Mario Monti's new government would have to take extra deficit-cutting measures beyond an austerity plan already adopted to meet its balance budget promise in 2013.
The Italian yields were above the levels at which Greece, Ireland and Portugal were forced to apply for international bailouts. But global stocks and the euro held firm on relief at strong demand for the Italian debt, with the maximum €7.5bn sold.
Looking to IMF if EFSF falls short
The Eurogroup ministers agreed to release their portion of an €8bn aid payment to Greece, the 6th instalment of €110bn of EU/IMF loans agreed last year and necessary to help Athens stave off the immediate threat of default.
Juncker said the money would be released by mid-December, once the IMF signs off on its portion early next month.
With Regling unable to put a single figure on the scaled-up EFSF, which EU leaders had hoped would reach €1 trillion, finance ministers said the IMF may have to provide more help, possibly bolstered with European money.
"We will have to look at the IMF which can also make available additional funds for the emergency fund. I think countries in Europe and outside of Europe should be prepared to give more money to the IMF," Dutch Finance Minister Jan Kees de Jager told reporters.
"We have talked about leverage though private money, but it would be two or two-and-a-half times an increase so not sufficient and we have to look for other solutions to complement the EFSF and that in my mind will be the IMF," he said.
With Germany opposed to the idea of the ECB providing liquidity to the EFSF or acting as a lender of last resort, the eurozone needs a way of calming markets.
The ECB shows no sign yet of responding to widespread calls to massively increase its bond-buying.
EU sources said one option being explored is for euro system central banks to lend to the IMF so it can in turn lend to Italy and Spain while applying IMF borrowing conditions.
"We will discuss with the ECB. The ECB is an independent institution, so we will put on the table some proposals and after that it is for the ECB to take the decision," Belgian Finance Minister Didier Reynders told reporters.
The ECB failed for the first time since May to fully offset €203.5bn in eurozone government bond purchases, adding to fears that the debt crisis is ratcheting up stress on the bloc's banking sector.
A Reuters poll of economists showed a 40% chance of the ECB stepping up bond-buying with freshly created money within six months, something it has opposed.
The poll forecast a 60% chance of an ECB rate cut to 1.0% next week and a big majority of economists said they expect the central bank to announce new long-term liquidity tenders to help keep banks afloat at its next meeting on December 8.
Indeed, Noyer said financial conditions in Europe had tightened as a result of the debt crisis and loss of confidence.
"There are now more downside risks to price stability," he said.
Monti to unveil his plans
Monti outlined his fiscal and economic reform plans to the eurozone ministers amid reports, officially denied in Rome and Washington, that Italy has held preliminary discussions with the IMF on financial support.
Italy has debts of €1.9 trillion - equivalent to 120% of national output - and needs to refinance some €340bn of maturing debt next year with big redemptions starting in late January.
Most analysts say the ECB will have to intervene more decisively on bond markets and the eurozone will have to agree eventually to issue common bonds, but Germany opposes both.
Berlin has pinned its efforts on a drive for closer fiscal integration among eurozone members.
Chancellor Angela Merkel told lawmakers she would not make a deal at a December 9 EU summit to drop resistance to joint eurozone bonds in exchange for progress on strengthening fiscal rules, MPs quoted her as saying.
She told a closed-door meeting Europe was "a long way from euro bonds", suggesting they may not be ruled out forever.
For now, Germany and France are pressing for coercive powers to reject eurozone members' budgets that breach EU rules, alarming some smaller nations who fear the plans bypass mechanisms for ensuring equal treatment.
Berlin and Paris aim to outline proposals for a fiscal union before the EU summit that is increasingly seen by investors as a last chance to avert a breakdown of the single currency area.
