Italy's six-month borrowing costs neared 3 percent at auction on Wednesday, their highest since December, piling pressure on the government as it pushes for concrete steps to ease market tensions at a European Union summit later this week.
Italy sold 9 billion euros of six-month bills at an average 2.96 percent yield, up from 2.10 percent it paid only a month ago. The Treasury faces a tougher market test on Thursday when it offers up to 5.5 billion euros in five- and 10-year debt.
"Today's bill sale points to the sovereign getting this supply away but at yield levels sufficiently elevated to leave a niggling doubt at least as to the medium-term sustainability of the country's public finances," said Richard McGuire, a rate strategist at Rabobank.
On Tuesday, Spain paid 3.24 percent to sell six-month bills. Madrid is seen at risk of having to ask for more aid after formally requesting a European rescue for its banks this week.
But doubts are also growing on Italy's ability to keep funding its 1.95 trillion euro debt, which makes it the world's fourth-largest sovereign debtor.
Wednesday's sale was covered 1.6 times, in line with a month ago, with demand helped by 9.9 billion euros of maturing bills.
Domestic appetite has so far allowed the Treasury to complete 56 percent of its 445-billion-euro annual funding plan.
But Italian banks may find it increasingly difficult to keep shouldering the country's large funding needs as foreign investors continue to shun its debt.
Italy's third-largest lender Monte dei Paschi dei Siena said on Wednesday it would progressively reduce its holdings of Italian government bonds, after tapping state aid to plug a capital shortfall partly due to its exposure to sovereign risk.
Prime Minister Mario Monti promised on Tuesday to press for joint action by EU countries to help ease pressure on Italian bonds, risking a showdown with Germany which refuses to share the burden of other countries' debt.
With its benchmark 10-year yields above 6 percent, Italy is calling for the euro zone's rescue funds to be used to ease pressure on its bonds. On Tuesday, it saw its two-year borrowing costs rise to 4.71 percent, al s o a six-month high, at a sale of zero-coupon paper.
Italian yields are still below peaks hit at the height of the crisis in November, when the threat of default precipitated a change of government. At that time, Italy paid a record 6.5 percent yield on six-month paper.
"While yields are not as high as they were in November, psychologically speaking things are almost just as dire," said Nicholas Spiro, at Spiro Sovereign Strategy.
A reform push by Italy's unelected government has stalled amid growing opposition from parties that back it in parliament and falling approval rates among recession-stricken Italians.
Monti is seeking final parliamentary approval on Wednesday for a long-awaited labour reform to strengthen his bargaining position ahead of the EU summit.
But German Chancellor Angela Merkel on Tuesday all but ruled out common euro zone bonds, seen by some economists as vital to restoring confidence in the euro, saying Europe would not share total debt liability for "as long as I live".
"While Italy has serious domestic problems, what concerns the markets is Germany's reluctance to do what is necessary in the short-term to shore up Spanish and Italian debt," Spiro said.