LONDON Key Italian and Spanish government bond yields hit their highest levels in 14 years on Tuesday on worries euro zone policymakers were stalling over efforts to resolve the debt crisis and avert a disorderly Greek default.
Euro zone finance ministers late on Monday promised cheaper loans, longer maturities and a more flexible rescue fund to help Greece and other EU debtors but failed to set a deadline to act, drawing Italy and Spain deeper into the crisis.
Dutch Finance Minister Jan Kees de Jager stoked market ire by saying a selective default for Greece was no longer being excluded.
Italian 10-year yields jumped more than 30 basis points on the day to break above 6 percent for the first time since 1997, approaching the 7 percent level analysts see as an unsustainable cost for Italy's borrowing needs.
They later slipped back below 6 percent on market talk the European Central Bank was buying Italian and Spanish bonds even though bond traders who normally see the trades said there was no sign of such purchases.
There was some relief that Italy managed to sell 6.75 billion euros of one-year paper though gross yields of 3.67 percent were the highest paid by Italy since September 2008, pointing to a costlier bond auction due on Thursday.
Traders and strategists said the respite could be short-lived in a volatile market with investors having little faith policymakers would deliver a quick solution.
"Without getting bogged down in a long list of policy errors during the crisis, current levels of Bund yields and periphery spreads probably best express just how much the market has lost faith in policymakers," Michael Leister, a strategist at WestLB said.
The 10-year BTP yield premium over benchmark Bunds was up 9 bps on the day at 315 bps, its highest since September 1996, though it was off an earlier high of 357 bps -- an expansion of 157 bps over the past three sessions. The equivalent Spanish spread was 15 bps wider on the day at 345 bps, with its 10-year yield remaining above 6 percent.
The scale and speed of the market moves have raised concerns over the cost of financing Italy's 1.6 trillion euro debt burden. This has prompted selling by international investors on the grounds that Italy was too large to be bailed out in the way Portugal, Greece and Ireland have been.
Benchmark German Bund futures were last up 59 ticks on the day at 129.73, off a session high of 130.91 as investors booked profits after the contract saw its biggest daily rally since March 2009.
Cash 10-year Bund yields were down six bps at 2.615 percent, their lowest since November, while the two-year Schatz yielded 1.22 percent, almost 30 bps less than the ECB's key refinancing rate as the market priced out expectations of further interest rates hikes this year.
"The crisis right now is possible illiquidity for Italy," said Peter Chatwell, a strategist at Credit Agricole.
"You've got BTP auctions on Thursday and from now until those auctions there's nothing that can be said to allay those fears of illiquidity."
(Graphics by Scott Barber; Editing by)