A "disastrous" German bond sale on Wednesday sparked fears that Europe's debt crisis was even starting to threaten Berlin, with the leaders of the euro zone's two biggest economies still firmly at odds over a longer-term structural solution.
Investors were also unnerved by reports that Belgium is leaning on France to pay more into emergency support for failed lender Dexia under a 90-bln-euro rescue deal that had appeared done and dusted.
A special report by Fitch Ratings suggested France had limited room left to absorb shocks to its finances like a new downturn in growth or support for banks without endangering its cherished AAA credit status.
After one of the least successful debt sales by Europe's powerhouse economy since the launch of the single currency, the euro fell to 1.336 to the dollar and European shares sank to 7-week lows.
The German debt agency was forced to retain almost half of a sale of 6 bln euros due to a shortage of bids by investors.
The result pushed the cost of borrowing over 10 years for the bloc's paymaster above those for the United States for the first time since October.
The new bond promised to pay out a 2.0% interest rate — the lowest ever on an issue of German 10-year Bunds. The auction's average yield was 1.98%, down from 2.09% for the previous benchmark in October.
Ten-year Bund yields were last up 12 basis points to 2.039% versus 1.946% for U.S. T-notes .
GERMAN EXPOSURE
Finance Minister Wolfgang Schaeuble's spokesman told a news conference that the auction did not mean the government has refinancing problems and few on financial markets disagreed.
But it was a sign that as the bloc's paymaster Germany may slowly be pressured if the crisis continues to deepen. One senior ratings agency official said it could give Berlin cause to re-examine its refusal to embrace a broader solution.
"It's quite telling that there has been upward pressure on yields in Germany – it might begin to change perceptions," David Beers of Standard & Poor's told a conference in Dublin.
The borrowing costs of almost all euro zone states, even those previously seen as safe such as France, Austria and the Netherlands, spiked in the last two weeks as panicky investors dumped paper no longer seen as risk-free.
"Bunds are starting to lose their appeal because markets have to believe the euro bonds story and Germany is very close to starting, essentially, to guarantee the debt of other countries," said Achilleas Georgolopoulos, strategist at Lloyds Bank in London.
The crux of an acceleration of the crisis in the past month is Italian bond yields' jump to levels around 7% widely seen as unbearable in the long term, despite intervention by the European Central Bank to buy limited quantities.
Determined not to be pushed around by financial markets, Merkel is resisting calls, most notably from France, to allow the ECB to act more decisively.
In a forceful speech to the Bundestag lower house of parliament, Merkel issued one of her starkest warnings yet against fiddling with the bank's strict inflation-fighting mandate. She also hit back at proposals from the European Commission on joint euro zone bond issuance, calling them "extraordinarily inappropriate".
STABILITY BOND
The chancellor has said the EU treaty bars the ECB from acting as a lender of last resort and printing money to buy government debt. She rejected joint "euro bonds", dismissed a proposal to mutualise the euro zone's debt stock, and rebuffed attempts to allow the bloc's rescue fund to borrow from the ECB or the IMF.
Yet at the same time, she has declared that the only answer to the crisis was "more Europe" and won endorsement from her party to press for a fully fledged European political union based around the euro zone.
With time running out for politicians to forge a crisis plan that is seen as credible by the markets, the European Commission presented a study on Wednesday of joint euro zone bonds as a way to stabilise debt markets.
