Italy at breaking point; fears grow of euro zone split

By Barry Moody and Andreas Rinke

ROME/BERLIN (Reuters) - Italian borrowing costs reached breaking point on Wednesday after Prime Minister Silvio Berlusconi's insistence on elections instead of an interim government threatened prolonged instability and kindled fears of a split in the euro zone.

European Commission President Jose Manuel Barroso issued a stern warning of the dangers of splitting the zone, rocked by an escalating debt crisis. EU sources told Reuters French and German officials had held discussions on just such a move.

"There cannot be peace and prosperity in the North or in the West of Europe, if there is no peace and prosperity in the South or in the East," Barroso said.

Italian 10-year bond yields shot above the 7 percent level that is widely deemed unsustainable, reflecting an evaporation of investor confidence and prompting German Chancellor Angela Merkel to issue a call to arms.

Merkel said Europe's plight was now so "unpleasant" that deep structural reforms were needed quickly, warning the rest of the world would not wait. "That will mean more Europe, not less Europe," she told a conference in Berlin.

She called for changes in EU treaties after French President Nicolas Sarkozy advocated a two-speed Europe in which euro zone countries accelerate and deepen integration while an expanding group outside the currency bloc stays more loosely connected -- a signal that some members may have to quit the euro.

"It is time for a breakthrough to a new Europe," Merkel said. "A community that says, regardless of what happens in the rest of the world, that it can never again change its ground rules, that community simply can't survive."

The European Central Bank, the only effective bulwark against market attacks, intervened to buy Italian bonds in large amounts but remained reluctant to go further.