DUBLIN Ireland warned on Thursday that a surge in its borrowing costs to record highs had become "very serious" and the EU said it was ready to act should the humbled former "Celtic Tiger" require a rescue from its euro partners.
European officials said they were monitoring developments in Ireland closely but denied for a second day running that Dublin was seeking financial aid, in an ominous echo of the rhetoric that preceded an EU/IMF bailout of Greece six months ago.
Unlike Greece, Ireland is fully funded through the middle of next year, meaning a liquidity crisis is not imminent.
But a Reuters poll of economists and bond strategists showed pessimism running high, with 20 out of 30 respondents saying the country was unlikely to make it through the end of 2011 without external assistance.
"The bond spreads are very serious and there is international concern throughout the euro zone about that," Irish Finance Minister Brian Lenihan said in Dublin.
He blamed part of the surge on "unintended" comments from German officials about a new permanent rescue mechanism for the euro zone that would force private debt holders to help shoulder the costs of future rescues.
Although Germany has made clear the new mechanism would not apply to existing debt, the plan has spooked markets, raising fears of a domino-effect on peripheral euro members that only weeks ago appeared to have weathered the worst crisis in the single currency's bloc's 11-year history.
Lenihan said Ireland was seeking clarification of the German plans and would soldier on without aid.
"We have the capacity to put the state on a sustainable and credible basis," he said.
Deeply unpopular and clinging to a razor-thin majority in parliament, Ireland's government is battling to prove it does not need a Greek-style rescue to help it reduce a budget deficit that will total 32 percent of gross domestic product (GDP) this year, easily the highest in Europe.
Markets are skeptical however, worried the government will struggle to win passage next month of a draconian 2011 budget that foresees 6 billion euros in cuts.
Jitters have pushed the yields on 10-year Irish bonds up to 9 percent from 6 percent in just three weeks.
Speaking to reporters at a Group of 20 summit in Seoul on Thursday, European Commission President Jose Manuel Barroso said the EU was ready to move should Ireland need assistance.
"What is important to know is that we have all the essential instruments in place in the European Union and euro zone to act if necessary," Barroso said, in comments welcomed by Lenihan.
BANK SHARES HIT
Irish bank shares fell sharply, reflecting renewed jitters about their exposure to the country's wrecked property market.
Shares in Allied Irish Banks shed 6 percent and Bank of Ireland was off 7 percent. The cost of insuring both banks against default surged to new highs on Wednesday, at over 900 and 700 basis points, respectively.
Foreign banks with a large exposure to Ireland, notably Royal Bank of Scotland, also fell.
In a sign of the broader worries haunting the euro zone, the cost of insuring sovereign Irish, Portuguese and Spanish debt against default also pushed up to record highs.
The spread between Irish 10-year bond yields and those of German benchmarks -- a key gauge of investor confidence in Irish finances -- rose above 680 basis points, hitting a new high for the ninth straight session.
"The market is chasing yields up and pushing Ireland in the direction of international bailout assistance," Marc Ostwald, a bond strategist at Monument Securities in London said.
The International Monetary Fund says markets are overestimating the risks of default in countries like Ireland. A recent report noted that of the 36 instances in the last two decades where a country's spreads rose above 1,000 basis points, only seven resulted in default.
But a consensus appears to be forming in the markets that Ireland will be forced to seek aid if its borrowing costs do not stabilize soon. Some are now speculating it may also have to restructure its debt, particularly if banks suffer more losses.
In a blog post on Thursday, University College Dublin economist Karl Whelan said a surge at the short-end of the Irish yield curve suggested markets now believed there was a high probability of a default as early as 2012.
"(This) strikes me as unwarranted. But it illustrates the scale of the current negative sentiment toward Ireland in the bond market," he wrote.
Prime Minister Brian Cowen's government has pledged to outline a four-year plan later this month to bring the ballooning budget deficit under control.
It then aims to push through the 2011 budget on December 7, a hurdle the leader of the main opposition party said on Thursday the government was likely to overcome.
However, some analysts say only an early general election that produces a new government with a stronger mandate may convince investors that Ireland can tackle its debt crisis.
Should Ireland fall, concerns about Portugal and probably Spain could rise, creating a vicious spiral that could drag the euro zone into another deep crisis with global implications.
(Additional reporting by Padraic Halpin in Donegal, Rachel Armstrong in Seoul, Jodie Ginsberg in Dublin; Writing by Noah Barkin, editing by Mike Peacock)