Spain paid levels not seen since 1997 to sell €3.2 billion of short-term debt today and Italy's 10-year yield climbed above 7 per cent as premier- in-waiting Mario Monti faced political resistance on forming a cabinet for his so-called technocrat government.

Solid demand allowed Spain to sell at the high end of its target range of between €2.5 billion and €3.5 billion of 12- and 18-month bills, but it sold less than its maximum target of debt at a bill sale today as financing costs increased.

Debt-ridden Greece also sold €1.3 billion of a 3-month treasury bill at 4.63 per cent - only two basis points up on the previous auction.

But the higher costs of borrowing on the Spanish issue reflected market moves that pushed 10-year bond yields to their highest since August, driven by concerns that Italy, the euro zone's third largest economy, will need a bailout.

A change of government in Italy gave markets barely a day of relief yesterday before investors went back into selling mode. Italian prime minister-designate Mario Monti will meet Italy's president tomorrow morning to inform him he will be able to form the country's next government, a statement from the presidential palace said on today.

Spain's ability to borrow faces a sterner test at an auction on Thursday of between €3 billion and €4 billion of a new benchmark 10-bond bond due January 31st 2022 with a 5.85 per cent coupon.

Bill sales are propped up by the need of domestic banks to park cash in the short-term but a yield above 5 per cent on one-year paper points to longer-term rates rising towards a 7-per cent level generally viewed as unsustainable.

The premium investors demand to hold such longer-term Spanish rather than German paper rose 4 basis points to 457 bps after the auction, hitting a new intra-day euro-era record high and their widest level since July 1995, according to Reuters data.

Traders reported that the European Central Bank was buying Italian bonds today but said it had little impact on market prices.

Growing concern that the euro zone's crisis is spiralling out of control even forced up AAA-rated government debt, with French spreads rising to their highest levels in over 20 years at 182 bps.

General elections in Spain on Sunday, which the centre-right is expected to win comfortably, have also stoked uncertainty over the euro zone's fourth largest economy.

"If the new government needs to borrow at these levels for the short term it won't be so bad and they'll be hoping a new wave of measures will help calm things down," economist at Capital Economics Ben May said.

"There is a risk, of course, this won't happen ... while there are fears of Italy or Spain needing a bailout, it's difficult to see yields falling."

Today, the treasury sold €2.6 billion of the 12-month T-bill at an average yield of 5.022 per cent compared to 3.608 per cent in September, with a bid-to-cover ratio of 2.1, below 2.3 previously.

The 18-month T-bill sold €558 million at an average yield of 5.159 per cent after 3.801 per cent a month earlier. The bills were 6 times subscribed compared to 4.3 times in October.

Some economists said the fact the Spanish treasury was able to sell the paper in current market conditions, even at a high price, was encouraging.

Reuters, Bloomberg