ROME – Italy's key borrowing rate spiked Wednesday well above the 7 percent level that eventually forced other eurozone countries to seek bailouts, amid uncertainty over who would lead the country when Premier Silvio Berlusconi steps down.
On Tuesday, Berlusconi said he would step aside for the good of the country once Parliament passes economic reforms and wouldn't run again for office. His move saw a brief rally in markets but sentiment quickly reversed as it remained unclear what government would take over.
The yield on Italy's 10-year bonds surged Wednesday to a high of 7.40 percent, up 0.82 of a percentage point from the previous day.
The 7 percent level is considered unsustainable for a government over the longer-term. Greece, Ireland and Portugal had to ask for rescue loans once it became clear that their borrowing rates were stuck above that threshold.
The key is how long the rate stays at that level.
"It takes time to permeate to the rest of the debt mountain," said Jan Randolph, head of sovereign risk analysis at IHS Global Insight. "Seven percent is not sustainable over several years. It has to be brought down eventually. Otherwise, we are in danger."
He noted that Italy is in better fiscal shape than either Greece or Portugal when they sought bailouts -- its deficit is below the eurozone average, but growth is weak.
But with debts of around euro1.9 trillion ($2.6 trillion), Italy is considered too big for Europe to bail out. Higher borrowing rates will make it more difficult and expensive for Italy to roll over its debts. It has over euro300 billion ($412 billion) to raise in 2012 alone.
In the meantime, Berlusconi is not yet out -- and there is considerable uncertainty of what kind of government will follow, contributing to market instability.
"Berlusconi is the supreme political maneuverer. And no one will believe he has resigned until, yes, he has done so. Simple as that," Randolph said. "He survived confidence votes before and he has made comebacks. No one really believes he is gone until he is gone."
While Berlusconi confirmed he wouldn't run for office again, he's by no means stepping out of the political limelight. In the La Stampa interview, he said he would remain active as the founder of his political party and would help out in political campaigns "which always turned out well for me."
The next government -- whether run by politicians or technocrats -- will likely face the same pressures as Berlusconi to enact quick reforms to shore up Italy's defenses against Europe's raging debt crisis.
"It is still far from clear that the alternative will materially improve proceedings," said Lee Hardman, an analyst at the Bank of Tokyo-Mitsubishi UFJ.
As Italy's borrowing rates ratcheted alarmingly higher, Milan's stock index was trading 4.3 percent lower at 15,002. Shares in Berlusconi's Mediaset empire were battered, trading down 9.8 percent.
There had been hopes that Berlusconi's announcement would help calm market jitters but Parliament must still pass legislation to curb Italy's debt and spur growth. No date has been set, but Berlusconi had previously indicated it could go up for a vote in the Senate as soon as next week.
Once Berlusconi resigns, Italy's president must decide on an interim government and if it will be led by politicians or technocrats. Berlusconi wants new elections soon with his hand-picked successor, Angelino Alfano, as a candidate.
"I won't run, actually I feel liberated," Berlusconi was quoted as telling La Stampa. "It's Alfano's turn."
Berlusconi tapped Alfano, his former justice minister, to head his People of Liberties Party a few months ago. At 41, Alfano represents a new generation of center-right politicians after 17 years of Berlusconi leadership.
Mario Monti, a former EU competition commissioner who now heads Milan's prestigious Bocconi University, has been widely tipped as a candidate to head a technical government.
Berlusconi conceded it was up to Napolitano to decide how to proceed once he steps down.
It's not clear that Napolitano would want to subject Italy to elections given the need to calm markets. He may try to sound out politicians about the possibility of forming either a government of technocrats or a broad-based government that could hold a majority in Parliament to finish the legislative period, which runs into 2013.
"The best case scenario is Mario Monti, and everyone rallies around him," said Randolph, the sovereign debt analyst.
Berlusconi's announced departure from office was greeted with relief among ordinary Italians but also wariness about what lies ahead.
"I'm more interested in what's going to happen afterwards," said Caterina Tassa as she bought newspapers at a kiosk near Rome's ancient Pantheon Wednesday morning. "The political class in general is very bad. So let's just say I'm not very calm."