IMF denies in Italy aid talks (Reuters)

By James Mackenzie and Francesca Landini James Mackenzie And Francesca Landini – Mon?Nov?28, 3:56?am?ET

ROME (Reuters) – Italy's prime minister faces a testing week as he seeks to shore up the country's strained public finances, with an IMF mission expected in Rome and market pressure building to a point where outside help may be needed to stem a full-scale debt emergency.

However, an IMF spokesperson poured cold water on a report in the Italian daily La Stampa that said up to 600 billion euros could be made available at a rate of between 4-5 percent to give Italy breathing space for 18 months.

"There are no discussions with the Italian authorities on a program for IMF financing," an IMF spokesperson said.

Adding to international pressure on euro zone leaders to stem the debt crisis, U.S. President Barack Obama will press senior European Union officials in Washington on Monday to reach a solution to the emergency that Moody's said now threatens the credit standing of all European government bond ratings.

After slumping last week, Asian shares and the euro rose on Monday on hopes that some measures may emerge this week to ease the crisis.

Euro zone finance ministers will meet on Tuesday to consider detailed rules to boost the impact of a 440-billion-euro rescue fund.

Germany and France are also exploring radical ways to secure deeper and more rapid fiscal integration among the bloc's 17 countries to shore up the region's defenses against the debt crisis.

Italian Prime Minister Mario Monti is expected to unveil measures on December 5 that could include a revamped housing tax, a rise in sales tax and accelerated increases in the pension age. But pressure from the markets could force him to act more quickly.

One source with knowledge of the matter said contacts between the International Monetary Fund and Rome had intensified in recent days as concern has grown that German opposition to an expanded role for the European Central Bank could leave Italy without a financial backstop if one were needed.

The IMF inspection team is expected to visit Rome in the coming days but no date has been announced.

EYE OF THE STORM

Italy is in the eye of the euro zone debt storm after its borrowing costs returned to the levels that triggered the collapse of former Prime Minister Silvio Berlusconi's center-right government. Yields on 10-year bonds ended last week at more than 7.3 percent.

Italian yields are now in the territory that forced Greece, Ireland and Portugal to seek international bailouts and an auction on Tuesday of up to 8 billion euros of BTP bonds will be a crucial test.

On Friday, Italy paid a euro lifetime high yield of 6.5 percent to sell new six-month paper, a level that analysts said cannot be maintained for long without pushing a public debt amounting to 120 percent of gross domestic product out of control.

European Central Bank member Christian Noyer said on Monday that Italy's economy was fundamentally sound and Rome should be able to restore market confidence if it shows fiscal discipline.

"Italy should not be considered a weak economy," Noyer told reporters on a visit to Tokyo.

Italy, the euro zone's third biggest economy, would be far too big for existing bailout mechanisms and default on its 1.8 trillion euro debt would cause a banking and financial crisis that would probably destroy the single currency.

It has more than 185 billion euros of bonds falling due between December and the end of April. Obama was due to hold talks on Monday with European Council President Herman Van Rompuy and European Commission President Jose Manuel Barroso, although no breakthroughs were expected.

The president was expected to reiterate he was confident that Europe's leaders could handle the crisis, which is emerging as a major worry for the 2012 U.S. elections, if they show political leadership.

Moody's warned in a report that it may take a series of shocks before the political impetus for a resolution to the debt crisis finally emerges. The crisis had deepened in recent weeks, it said.

"The probability of multiple defaults (in addition to Greece's private sector involvement program) by euro area countries is no longer negligible," it said.

Civil servants from Germany and France were exploring ways for more rapid fiscal integration after the realization that getting an agreement among all 27 countries in the EU will be difficult any time soon.

An agreement among just the euro zone countries is one option.

"The goal is for the member states of the common currency to create their own Stability Union and to concentrate on that," German Finance Minister Wolfgang Schaeuble told ARD television on Sunday.

Another option being explored is a separate agreement outside the EU treaty that could involve a core of around 8-10 euro zone countries, officials say.

PRESSURE

Monti outlined the broad thrust of his reform plans earlier this month, promising a mix of budget rigor and reforms to stimulate economic growth, and has stuck to Berlusconi's pledge to balance the budget by 2013.

But with growing signs that Italy's chronically sluggish economy could be entering recession, he has come under pressure to provide concrete details quickly.

The measures outlined so far are broadly in line with directions previously given by the ECB, but there have been no detailed discussions with international bodies on the kinds of conditions normally attached to IMF assistance programs.

As well as loosening job protection measures, privatizing local services and opening up professions to more competition, additional budget measures estimated by Italian media at up to 15 billion euros could be announced.

Monti can take some comfort from surveys showing broad popular support for his technocrat government, but austerity measures have yet to bite deeply and surveys also show a mixed picture on individual austerity measures.

On pensions, the government is expected to bring forward an already-planned increase in retirement ages, with a wider reform possible in the coming weeks.

Monti may reintroduce a housing tax that was scrapped by Berlusconi in a last-minute campaign pledge before the 2008 election. The move cost the Treasury an estimated 3.5 billion euros a year.

Other ideas under consideration include raising the value-added tax band in bars and restaurants, which currently stands at 10 percent.

(Additional reporting by Gavin Jones and Steve Scherer and Lesley Wroughton in Washington; Ian Chua in Sydney and Stanley White and Rie Ishiguro in Tokyo; Editing by David Stamp, Alessandra Rizzo and Alex Richardson)

Moody's cuts Italy credit rating by three notches (Reuters)

NEW YORK/ROME (Reuters) – Moody's Investors Service cut Italy's bond ratings by three notches on Tuesday, saying it saw a "material increase" in funding risks for euro zone countries with high levels of debt.

Moody's downgraded Italy's ratings to A2 from Aa2, a lower rating than that of Estonia, and kept a negative outlook on the rating, a sign that further downgrades are possible within the next few years.

The move comes after Standard and Poor's cut its rating on Italy to A/A-1 from A+/A-1+ on September 19 and underlines growing investor uncertainty about the euro zone's third largest economy, which is now firmly at the center of the debt crisis.

"The negative outlook reflects ongoing economic and financial risks in Italy and in the euro area," Moody's said in a statement.

"The uncertain market environment and the risk of further deterioration in investor sentiment could constrain the country's access to the public debt markets," it said.

Moody's also said that Italy's rating could "transition to substantially lower rating levels" if there were long-term uncertainty over the availability of external sources of liquidity support.

Italy's mix of chronically low growth, a huge public debt amounting to 120 percent of gross domestic product and a struggling government coalition has caused mounting alarm in financial markets.

The Moody's decision came as little surprise after the agency said on September 17 that it would finish a review for possible downgrade of its rating on Italy within a month.

"It's not that it was unexpected, but it doesn't help the situation at all," said Robbert Van Batenburg, Head of Equity Research, at Louis Capital in New York.

"They have already traded as if there was somewhat of a downgrade in the works, so it will probably force Italian policymakers to embark on more austerity programs. It will put another fiscal straitjacket on them," he said.

Moody's said the likelihood of a default by Italy was "remote," but the overall shift in sentiment on the euro area funding market implied a greater vulnerability to a loss of market access at affordable interest rates.

Italy's borrowing costs have soared over the past three months and have only been kept under control by the European Central Bank's purchase of its government bonds on secondary markets.

An auction of long-term bonds last month saw yields on 10 year BTPs rise to 5.86 percent, their highest level since the introduction of the euro more than a decade ago.

The center-right government of Prime Minister Silvio Berlusconi has been under heavy pressure over its handling of the escalating crisis and recently cut its growth forecasts through 2013.

It is now expecting the economy to expand by just 0.6 percent next year, down from a previous projection of 1.3 percent.

The government last month pushed through a 60 billion euro austerity package -- bringing forward by one year to 2013 a goal to balance its budget -- in return for support for its battered government bonds from the ECB.

(Reporting by Walter Brandimarte and Daniel Bases In New York, Catherine Hornby and James Mackenzie in Rome; Editing by Gary Crosse)

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Italy minister says no pressure on ECB over bonds (Reuters)

CERNOBBIO, Italy (Reuters) – Economy Minister Giulio Tremonti promised on Sunday to meet Italy's budget pledges after growing speculation over whether the European Central Bank may cut back its purchases of Italian government debt.

Tremonti, under mounting pressure to present a credible plan to fulfill a pledge of balancing the budget by 2013 and cutting Italy's 1.9 trillion euro debt pile, told a business conference in the northern town of Cernobbio that the target would be met.

However he admitted that a hastily put-together package of measures presented to parliament in August and now undergoing substantial revision, had been incomplete.

"When you take measures in four days you can make mistakes, it's true," he told a conference discussion.

The regular Ambrosetti conference in Cernobbio near Milan this weekend has brought growing doubts about the 45.5 billion euro austerity package to a head following a week of rising market pressure on Italian government bonds.

Both ECB President Jean-Claude Trichet and Italy's head of state, President Giorgio Napolitano issued strong calls for swift action following widespread criticism of the haphazard way in which the plan was being handled.

Marco Tronchetti Provera, chairman of tyremaker Pirelli, one of the icons of Italian industry, said Tremonti's speech to the conference had been clear but it had not eliminated doubts about the gravity of the situation.

"I repeat that anyone who is not concerned about this situation is making a mistake," he told reporters.

The head of Confindustria, Italy's largest employer federation also took aim at the government during the conference, saying the plans presented so far did not do nearly enough to stimulate the country's anaemic growth rates.

Underlining the growing concerns, the premium investors demand to hold Italian debt rather than benchmark German bonds rose on Friday to 331 basis points, the highest since the ECB started buying Italian paper in August.

Yields on 10-year Italian bonds ended the week at 5.29 percent, creeping back up toward the 7 percent level generally regarded as unmanageable.

ECB INTERVENTION

With the spreads over German debt widening ominously, there was growing speculation over whether the ECB would continue buying Italian debt, a strategy that has caused sharp divisions within the Frankfurt-based central bank.

The ECB has been buying Italy's bonds in the market to try to hold down yields and stop Rome's borrowing costs spiralling out of control, there has been a growing sense of frustration that the government has not done enough itself.

"Our biggest concern is that the ECB might halt its purchases of Italian bonds, which would cause spreads to widen again," the head of Confindustria, Emma Marcegaglia, told reporters. "In this case, Italy would have huge problems."

On Saturday, Trichet declined to comment on the bond buying programme ahead of a Governing Council meeting on Thursday.

Italy, the euro zone's third largest economy, has been dragged ever closer to an emergency that could overwhelm any existing euro zone bailout mechanisms. But there have been worries in Germany that the ECB is blurring the lines between monetary policy and governments' own fiscal responsibilities.

Italy's Foreign Minister Franco Frattini, who said on Saturday that the government was pressing the ECB to keep up the purchases, backtracked on Sunday, saying the central bank was independent and Rome was not exerting pressure.

Tremonti offered no substantial new pledges on the timing or substance of the austerity package, which has been subject of repeated changes and dispute over the past weeks.

However he repeated his longstanding call for jointly issued euro bonds, which have been rejected by Germany.

"The euro bonds will absolutely be done," he said. "Either we do euro bonds or we will have critical problems," he said.

Frattini told reporters the Senate would approve the new package by the end of next week and that approval from the Lower House would follow swiftly.

"I don't see any reason why the government should ask for a confidence vote on the budget," he added.

(Writing by James Mackenzie, editing by Rosalind Russell)

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ECB eyes decision on Italy bond buys to ease debt (Reuters)

FRANKFURT/PARIS (Reuters) – The European Central Bank faced a decision on Sunday whether to buy Italian bonds to try to prevent the euro zone debt crisis from widening, while global policymakers conferred on the twin financial crises in Europe and the United States.

After a week that saw $2.5 trillion wiped off world stock markets, political leaders are under searing pressure to reassure investors that Western governments have both the will and ability to reduce their huge and growing public debt loads.

ECB President Jean-Claude Trichet wants the policy-setting Governing Council to take a final decision on buying Italian paper after Prime Minister Silvio Berlusconi announced new measures on Friday to speed up deficit reduction and hasten economic reforms, one ECB source said.

The source said that if the ECB council opted to intervene on Italy at a crucial conference call expected to have started at 1700 GMT (1200 EDT), the ECB and national central banks would start buying Italian bonds when markets open on Monday.

That would likely prompt a sizable relief rally on global markets. If it does not act, the reverse would be true.

Another source said the council would look too at possible emergency liquidity measures to prevent money markets freezing. The fourth anniversary of the global credit crunch which ushered in the financial crisis looms this week.

The back-and-forth between Standard & Poor's and the Obama administration over whether the downgrade of Washington's AAA rating to AA+ was justified continued on U.S. Sunday-morning talk shows where a senior official from the ratings agency said its concerns about political impasse in Washington were valid.

John Chambers, an S&P managing director, said on ABC's "This Week" that years may be needed to regain AAA status and even them "it would take, I think, more ability to reach consensus in Washington than what we're observing now."

White House economic adviser Gene Sperling blasted the S&P ruling on Saturday night, saying it "smacked of an institution starting with a conclusion and shaping any arguments to fit it."

The U.S. Treasury said S&P's debt calculations were off by $2 trillion but the agency said that didn't change the fact that the U.S.'s longer-term debt prospects were worsening.

Twin debt crises in the United States and Europe had policy makers scrambling to keep financial markets from panic.

The ECB reactivated its sovereign bond-buying programme last Thursday but purchased only small quantities of Irish and Portuguese bonds, seeking tougher austerity measures from Italy. That did nothing to stem market attacks on Italian assets.

Berlusconi's plans entail moving up a balancing of the budget by one year to 2013, enshrining a balanced budget rule in the constitution and pushing through welfare and labor market reforms after talks with trade unions and employers.

He gave little detail about how that would be achieved and the measures will take some time to enact.

Markets in the Gulf region and in Israel, among the first to trade since the U.S. credit downgrading, tumbled on Sunday on worries the U.S. ratings downgrade and European debt woes may trigger another global downturn.

G-20, G-7 CRISIS CONTACTS

South Korea said finance deputies from the Group of 20 big economies addressed the European crisis and U.S. sovereign rating downgrade in an emergency conference call on Sunday morning Asian time.

A Japanese government source said finance leaders from the Group of Seven big developed economies would also discuss the crisis and might issue a statement afterwards. The timing of a planned conference call, expected on Sunday, was unclear but was likely before Asian markets reopen on Monday.

French President Nicolas Sarkozy, who chairs the G7 and G20 forums this year, conferred with Britain's Prime Minister David Cameron on Saturday.

"Both agreed the importance of working together, monitoring the situation closely and keeping in contact over the coming days," a spokesman for Cameron said.

Over time, S&P's move could ripple through markets by pushing up borrowing costs and making it more difficult to secure a lasting recovery.

S&P chief David Beers told "Fox News Sunday" that the Treasury Department's criticism of the credit rating agency's analysis was a "complete misrepresentation." Even with the debt limit agreement passed by the U.S. Congress, he said, "the underlying debt burden of the U.S. is rising and will continue to rise over the next decade."

Asked about prospects for a further lowering of the U.S. rating, Beers said the agency's negative outlook meant that "risks are on the downside."

ALARM IN GERMAN, FRENCH MEDIA

Newspapers in Germany, the euro zone's reluctant bankroller, were both incredulous and gloomy on Sunday about the financial upheaval.

Welt am Sonntag dedicated an entire section to global economic uncertainties, entitled "Der Crash" and wrote: "No one could have foreseen this dramatic crash and now the situation can only be endured with gallows humor."

French newspapers carried grim headlines with Le Journal du Dimanche trumpeting "The world on the edge of collapse" with a sub-headline saying: "The week starting should be crucial. Markets from now on are living in fear of a crash."

Washington's Asian allies rallied round the battered superpower, with Japan and South Korea both saying their trust in U.S. Treasuries remained unshaken and urging investors not to panic.

"I expressed our country's position on the (G20 conference) call that there will be no sudden change in our reserve management policy," South Korean Deputy Finance Minister Choi Jong-ku told Reuters by telephone, referring to Seoul's heavy ownership of U.S. bonds.

"There's no alternative that provides such stability and liquidity," added Choi.

The most immediate concern for financial markets was the debt crunch in the euro zone, where yields on Italian and Spanish debt have leaped to 14-year highs on political wrangling and doubts over the vigor of budget cuts.

"The ECB has got to confront the speculators who are out to test the policymakers," said Mike Lenhoff, chief strategist at Brewin Dolphin in London. "(The U.S. downgrade) might cause some upheaval temporarily. The big issue is the euro zone and its implications for the banking system."

SPLITS IN ECB

The ECB remains divided over whether to buy bonds at all, with four German, Dutch and Luxembourg members of the 23-member council opposed, ECB sources said. Even some of those in favor say Italy should do more to front-load its reforms.

The danger is that further pressure on Italian and Spanish bonds could further undermine a damaged European banking system and lock Italy, the world's No. 8 economy, out of the market.

Indeed, doubts are growing in the German government that Italy could be rescued by the European emergency fund, even if the fund were tripled in size, according to Der Spiegel.

Italy's financial needs are so huge that it would overwhelm resources, according to government experts, Der Spiegel said in its online edition. Italy's public debt is about 1.8 trillion euros, or 120 percent of its national output.

Germany has consistently said troubled euro-zone governments should focus on spending cuts and internal reforms, not bailouts. The European Financial Stability Fund currently has 440 billion euros and would need to be expanded to cater for the likes of Italy and Spain.

China, the largest foreign holder of U.S. debt, took the world's economic superpower to task for allowing its fiscal house to get into such disarray.

On Sunday, a commentary in the People's Daily, the main newspaper of the ruling Communist Party, said Asian exporters, who depend on demand from the United States, could be among the biggest victims of the mounting U.S. economic woes.

"The lowering of the United States' long-term sovereign credit rating has sounded a warning bell for the international currency system dominated by the U.S. dollar," said economist Sun Lijian, writing in the paper.

(Additional reporting by Laura McInnis in Washington, Tova Cohen in Tel Aviv, Sarah Marsh in Berlin, Astrid Wendlandt in Paris, Kim Yeonhee and Yoo Choonsik in Seoul, Praveen Menon and Shaheen Pasha in Dubai, and Reuters bureaux worldwide; Writing by Mark Heinrich and Glenn Somerville; Editing by Jackie Frank)

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Italy political consensus helps calm markets (Reuters)

ROME (Reuters) – A quick agreement by Italy's government and opposition to pass a closely watched austerity package helped calm markets on Wednesday, but there were calls for further steps to reductions in the deficit.

Facing a market rout after stocks plunged and borrowing costs hit record highs on Tuesday, government and opposition parties shelved their differences and agreed to ensure quick approval of a four-year, 40 billion euro austerity plan.

"The market remains nervous, very attentive, but we had an Italian reaction that was remarkably fast on budget austerity," said Deutsche Bank analyst Gilles Moec.

"The growth issue remains, but there was an immediate, patriotic reaction by the Italian political class that has positively impressed investors."

Economy Minister Giulio Tremonti, widely seen as the guarantor of Italian financial stability, said the government's austerity package would be approved by Friday, and he brushed aside rumors that he may step down.

"Hic manebimus optime," he told a meeting of the Italian banking association, borrowing a phrase from the Roman historian Livy meaning: "We will stay here, extremely well."

At the same event, European Central Bank Governing Council member Mario Draghi urged the government to move ahead with further measures to ensure it meets its target of bringing the budget back into balance by 2014.

"The substance of future measures aimed at balancing the budget by 2014 should be defined as rapidly as possible," he said. "This is what markets are looking at above all today."

He also criticized the European policy response to the debt crisis, saying policymakers needed to "bring certainty to the process by which sovereign debt crises are managed" with clearly defined objectives and instruments.

International Monetary Fund economists have urged "decisive implementation" by Italy to cut its huge public debt, noting that the austerity plan was based on optimistic forecasts with measures weighted toward later years.

Market falls on Friday and Monday wiped around 26 billion euros off the FTSE MIB blue-chip index and sent Italian bond yields up to more than 6 percent, the highest since the launch of the euro more than a decade ago.

On Wednesday, the premium investors demand to hold Italian debt rather than safe-haven German bonds narrowed by 11 basis points to 280 basis points -- after hitting a euro lifetime high of 353 basis points at one stage on Tuesday.

The yield on the 10-year BTP bond stood at 5.46 percent, down 13 basis points but still 46 basis points higher than its levels a week ago.

With the BTP spread against German Bunds narrowing, Italian bank shares -- which have born the brunt of the sell-off because of their vast holdings of government paper -- recovered some of the heavy losses they had suffered on Friday and Monday.

However, Goldman Sachs cut its price targets on Italian banks by 12 percent on average due to expected higher funding costs and lower profitability after the recent rise in Italian government bonds.

MARKET TEST LOOMS

A further test of Italy's ability to keep tapping the markets comes on Thursday, when the Treasury offers up to 5 billion euros of long-term BTP bonds, and markets are waiting nervously to see how the auction succeeds.

If Italy, the third-largest economy in the euro zone, were to share the same fate as Greece or Ireland, consequences would be incalculable. Much too big to bail out, a severe crisis could call the future of the entire euro area into question.

Ratings agency Fitch said on Wednesday it expected the government to succeed in cutting the deficit and said the market turmoil did not reflect Italy's fundamentals.

"The sharp rise in Italian and other euro zone government bond yields in recent weeks reflect a crisis of market confidence in the European policy response to the euro zone debt crisis rather than deteriorating sovereign credit fundamentals," Fitch said in a statement.

Italy has a public debt equivalent to around 120 percent of gross domestic product, second only to Greece in the euro zone and compounded by one of the world's most anemic growth rates.

Tight spending controls, a conservative banking system and a high rate of private savings have helped shield it from the worst of the euro zone debt crisis, but the sell-off this week is a reminder of its potential vulnerability.

A senior Bank of Italy official said the impact of the recent surge in yields was limited in the short term but would be considerable if it persisted -- adding around 3 billion euros to government borrowing costs in the first year and more later.

"If these kind of levels persist, the burden for public finances would be severe," Ignazio Visco, deputy director general of the Italian central bank, told a Senate hearing.

(Additional reporting by Giuseppe Fonte, Michel Rose, Valentina Za, Nigel Tutt, Luca Trogni and Elvira Pollina in Milan; Writing by Silvia Aloisi and James Mackenzie; Editing by Hugh Lawson)

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Eurozone mulls Greek options, fears spread to Italy (Reuters)

BRUSSELS (Reuters) – EU finance officials will discuss a range of options for Greece's intractable debt crisis on Monday, galvanized by the growing threat of contagion to Italy, the euro zone's third-largest economy.

A senior European Union source told Reuters the Eurogroup of 17 euro zone finance ministers meeting later would discuss the possibility of buying back Greek debt or the private sector swapping holdings for longer-dated maturities.

If so, it suggests a French plan that would have involved private sector creditors rolling over around 70 percent of their Greek debt into 30-year bonds and other AAA-rated securities is losing favor and other options are back under the microscope.

Germany, the Netherlands, Austria and Finland are determined that banks, insurers and other private holders of Greek government bonds should bear a chunk of the costs of a second Greek bailout, which is expected to total 110 billion euros.

But after weeks of negotiations with bankers, there has been next to no progress on agreeing a formula acceptable to all sides.

As the French plan has faltered, Berlin has revived a proposal to swap Greek bonds for longer-dated debt that would extend maturities by seven years. Proposals to buy back Greek bonds and retire them have also been floated.

"We need to find a way to have some guidelines today on the private sector involvement and the solution for Greece," Belgian Finance Minister Didier Reynders told reporters. "That's the real issue today, I'm sure."

The senior EU source said the Eurogroup would task technical groups with working on the two options -- bond buybacks and a debt rollover.

"There is a strong possibility that a new Eurogroup meeting will be called at the end of July, to sign off on the solutions," the source said.

Both those schemes would likely be regarded by ratings agencies as a default, or at best a selective default, which could have profound repercussions for global financial markets.

The European Central Bank insists it will not accept anything that is termed a default, a position Germany also holds even if some policymakers may be edging closer to effectively condoning a default to achieve a write-down in the value of Greek debt to make its debt mountain more sustainable.

"We do pursue a voluntary basis but it has to be substantial private sector involvement. That's our commitment and also our parliament that demands it," Dutch Finance Minister Jan Kees De Jager said.

In a buy-back, the bloc's European Financial Stability Facility (EFSF) bailout fund might buy Greek bonds from the market, or lend Greece money to do so. Officials say that would require changes to the EFSF's rules which would need the backing of national parliaments -- a further potential obstacle.

ITALY FOCUSING MINDS

Policymakers have been seized with a new sense of urgency after Italy came under market attack last week, fearing any further delay in putting together a second Greek package could poison investor confidence in weak economies around the region.

After talking by phone to Italy's Silvio Berlusconi, German Chancellor Angela Merkel said Rome needed to demonstrate it was undertaking the budget reforms needed to restore confidence and she was confident that it would do so.

Herman Van Rompuy, the president of the European Council, met ECB President Jean-Claude Trichet and Jean-Claude Juncker, the chairman of the Eurogroup, for talks in Brussels ahead of the euro zone finance ministers' gathering.

Van Rompuy's spokesman described the meeting, which European Commission President Jose Manuel Barroso and EU economic and monetary affairs commissioner Olli Rehn also attended, as a "coordination, not a crisis meeting."

He said Italy was not on the agenda but senior EU sources said it would be impossible not to discuss it following a large sell-off in bonds and stocks that the Italian media have dubbed "black Friday."

The cost of insuring Italian debt against default jumped to a record high on Monday, the 10-year yield spread over German debt widened to a euro-era high of 268 basis points and bond yields neared the 5.5-5.7 percent area which bankers say will start putting heavy pressure on Italy's finances.

The sell-off has increased fears that Italy, with the highest sovereign debt ratio relative to GDP in the euro zone after Greece, could be next to get dragged into crisis. If that came to pass, the euro zone's existing rescue mechanism, the EFSF, would have insufficient funds to help.

Austria's Finance Minister Markia Fekter said ministers wanted to quiz Italy about how it was handling the situation.

"We have a Eurogroup meeting today and tomorrow Ecofin. We will (discuss) the IMF decisions and we will also have questions for the Italian minister there," she told reporters.

The market pressure is due in part to Italy's high sovereign debt and sluggish economy, but also due to concern that Prime Minister Silvio Berlusconi may be trying to push out his long-time finance minister, Giulio Tremonti, who has promoted deep spending cuts to control the budget deficit.

"We can't go on for many more days like Friday," a senior ECB official told Reuters. "We're very worried about Italy."

German newspaper Die Welt quoted an unnamed ECB source as saying the EFSF may have to be doubled in size to 1.5 trillion euros if it is to be capable of coming to the aid of Italy.

(Additional reporting by John O'Donnell in Brussels, Silvia Westall in Vienna, Stephen Brown in Berlin and Milan/Rome bureaus, writing/editing by Mike Peacock)

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Exclusive: EU calls emergency meeting as crisis stalks Italy (Reuters)

BRUSSELS (Reuters) – European Council President Herman Van Rompuy has called an emergency meeting of top officials dealing with the euro zone debt crisis for Monday morning, reflecting concern that the crisis could spread to Italy, the region's third largest economy.

European Central Bank President Jean-Claude Trichet will attend the meeting along with Jean-Claude Juncker, chairman of the region's finance ministers, European Commission President Jose Manuel Barroso and Olli Rehn, the economic and monetary affairs commissioner, three official sources told Reuters.

Van Rompuy's spokesman Dirk De Backer said: "It's a coordination, not a crisis meeting." He added that Italy would not be on the agenda and declined to say what would be discussed.

However, two official sources told Reuters that the situation in Italy would be discussed. The talks were organized after a sharp sell-off in Italian assets on Friday, which has increased fears that Italy, with the highest sovereign debt ratio relative to its economy in the euro zone after Greece, could be next to suffer in the crisis. A second international bailout of Greece will also be discussed, the sources said.

The spread of the Italian 10-year government bond yield over benchmark German Bunds hit euro lifetime highs around 2.45 percentage points on Friday, raising the Italian yield to 5.28 percent, close to the 5.5-5.7 percent area which some bankers think could start putting heavy pressure on Italy's finances.

Shares in Italy's biggest bank, Unicredit Spa, fell 7.9 percent on Friday, partly because of worries about the results of stress tests of the health of European banks that will be released on July 15. The leading Italian stock index sank 3.5 percent.

The market pressure is due partly to Italy's high sovereign debt and sluggish economy, but also to concern that Prime Minister Silvio Berlusconi may be trying to undermine and even push out Finance Minister Giulio Tremonti, who has promoted deep spending cuts to control the budget deficit.

"We can't go on for many more days like Friday," a senior ECB official said. "We're very worried about Italy."

Monday's emergency meeting will precede a previously scheduled gathering of the euro zone's 17 finance ministers to discuss how to secure a contribution of private sector investors to the second bailout of Greece, as well as the results of the stress tests of 91 European banks.

GREECE

Greece is already receiving 110 billion euros ($157 billion) of international loans under a rescue scheme launched in May last year but this has failed to change market expectations that it will eventually default on its debt.

Senior euro zone officials worry that progress toward a second Greek bailout, which would also total around 110 billion euros, is not being made quickly enough and that the delay is poisoning investors' confidence in weak economies around the region.

"We need to move on this in the next couple of weeks. It's not a case of waiting until late August or early September as Germany is saying. That's too late and markets will make us pay for it," a top euro zone official told Reuters on Saturday.

German officials insist they too want to put together the second Greek bailout as quickly as possible, but the private sector's contribution is proving to be a major sticking point.

Germany, the Netherlands, Austria and Finland are determined that banks, insurers and other private holders of Greek government bonds should bear some of the costs of helping Athens. But more than two weeks of negotiations with bankers represented by the Institute of International Finance (IIF), a lobby group, have made next to no progress on agreeing a formula acceptable to all sides.

Initially talks focused on a complex French plan for private creditors to roll over up to 30 billion euros of Greek debt, buying new bonds as their existing ones matured. Around half of proceeds from Greek bonds maturing before the end of 2014 would be rolled over into very long-term debt while 20 percent would be put into a "guarantee fund" of AAA-rated securities.

But as that plan has floundered, Berlin has revived a proposal to swap Greek bonds for longer-dated debt that would extend maturities by seven years. Proposals to buy back Greek bonds and retire them have also been floated.

In a buy-back, the euro zone's bailout fund, the European Financial Stability Facility, might buy Greek bonds from the market, or the EFSF might lend Greece money to buy bonds. However, these schemes would require further changes to the EFSF's rules and would therefore have to go through national parliaments, an official source said.

SQUARE ONE

A senior euro zone official told Reuters on Friday that rather than progress being made in the talks with the IIF, as IIF managing director Charles Dallara has said, all sides were close to being "back to square one."

Dallara will attend the meeting of euro zone finance ministers in Brussels on Monday.

Since the euro zone's debt crisis erupted last year, the region's rich governments have aimed to limit it to Greece, Ireland and Portugal, which have signed up to bailouts totaling 273 billion euros -- a sum that is small compared to the financial resources of the zone as a whole.

Spain, commonly seen as the next potential domino in the crisis, has managed to retain its access to market funding through fiscal reforms. But because of the large sizes of the Spain and Italy, pressure on the euro zone would increase dramatically if those countries eventually needed financial assistance.

(Additional reporting by Francesca Landini in Milan and Gernot Heller in Berlin; Editing by Andrew Torchia)

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