MILAN (Reuters) - Italy's benchmark borrowing costs hit six-month highs at auction on Thursday, piling pressure on Prime Minister Mario Monti to ease a steepling debt burden by squeezing concessions out of Germany at a European summit later in the day.
The Treasury sold 5.42 billion euros in 10-year bonds, near the top of its lower-than-average target range, helped by domestic demand fed by large redemption flows.
But 10-year yields rose to 6.19 percent from 6.03 percent a month ago, fuelling concern on markets.
"The good news is that the Treasury once again got its debt out the door. The bad news is that the yield levels are punitive," said Nicholas Spiro at Spiro Sovereign Strategy.
Weakened by falling popularity and a fractious political climate as Italy sinks deeper into recession, Monti is anxious to gain some relief at the Brussels summit for the painful borrowing costs now being borne by the world's fourth-largest sovereign debtor.
Italian President Giorgio Napolitano highlighted the difficult political situation on Thursday, saying he was worried by the increasing tensions among the parties backing Monti's unelected government.
French President Francois Hollande said he wanted "very rapid solutions" to help countries that face difficulties on the markets. But German Chancellor Angela Merkel has shown no sign of giving up her refusal to underwrite other euro zone countries' debts.
Berlin pays only a quarter of the interest to sell its 10-year debt that Rome does.
In a bid to strengthen his bargaining position with EU partners ahead of the summit, Monti won parliamentary backing late on Wednesday for a long-delayed labor reform.
He has also said he was prepared to go on negotiating into Sunday evening if necessary to agree on measures to calm markets before they re-open next week.
But Germany is skeptical about new tools to stem the crisis, and wants fiscal controls to be place before agreeing to any joint liability for debt.
A German government source warned on Thursday against "exaggerated panic-mongering" over Spanish and Italian yields.
Italy also sold a five-year bond at an average 5.84 percent on Thursday, up from 5.66 percent a month ago and the highest since a euro-lifetime peak of 6.5 percent in December.
Later on Thursday the Treasury placed another 825 million euros of the two bonds, at a supplementary auction held a day early because of a public holiday in Rome on Friday.
Primary dealers also bought another 1.35 billion euros of a six-month bill auctioned on Wednesday at a yield near 3 percent.
Ireland's finance minister said on Thursday that measures to lower Italian yields would top the summit agenda. But analysts expect Italian and Spanish bond yields to remain under pressure.
"The summit is likely to take a step in the right direction, but ultimately underwhelm," said Citi analyst Jamie Searle.
Monti's political woes have contributed to the rise in Italian yields and investors are looking with alarm at the possibility of early elections in the euro zone's third economy.
"I believe the outcome of the EU summit will disappoint," said Biagio Lapolla, a strategist at RBS in London.
"Given that Italian parties do not expect Monti to come back empty-handed, attention may then turn to Italy's political scene, and it would not be positive."
Domestic demand has helped the Treasury to meet roughly 58 percent of its annual funding plan so far, while foreign investors continue to shun Italian bonds.
But analysts say Italian lenders may find it increasingly hard to keep shouldering the bulk of the Treasury's issuance.
Italy's third-largest bank, Monte dei Paschi di Siena, said on Wednesday it would reduce its Italian bond holdings, after tapping state aid this week to fill a capital gap partly due to its large exposure to sovereign risk.
Additional reporting by London and Milan government bond desks; Editing by Kevin Liffey