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Italy seeks bigger euro fund after tough debt sale

By Valentina Za and Steve Scherer

MILAN/ROME (Reuters) - Italian Prime Minister Mario Monti sought reinforcement for the euro zone's bailout fund and pledged new efforts to boost the economy after a disappointing bond auction on Thursday underlined the threat to the country's shaky public finances.

Investors demanded a yield of nearly 7 percent on 10-year paper at the auction of medium- and long-term bonds, down from the record highs seen last month but still unsustainable given the 450 billion euros ($580 billion) that Italy needs to raise through debt issuance in 2012.

An unprecedented European Central Bank injection last week of nearly half a trillion euros of cheap funding for banks eased pressure at a short-term Italian debt auction on Wednesday, but longer-dated bonds still pose a challenge.

Monti put a brave face on the auction result, which analysts described as "slightly positive" or "average" at best.

"Auctions held yesterday and today went rather well, this is encouraging but the financial turbulence absolutely isn't over," Monti said during a traditional end-year press conference.

Italy, the euro zone's third largest economy, remains at the centre of the debt crisis that began in Greece two years ago and its borrowing needs could overwhelm the bloc's financial defenses if it were forced to seek an international bailout.

"A lot of work remains to be done but from this point on, this work has to be done in Europe above all," Monti said.

He said the European Financial Stability Facility, the bailout fund set up by euro zone governments, needs "significantly greater" resources but refused to quantify how much more was required.

Monti promised to outline a first package of growth measures to European partners next month and said the emphasis would be on liberalizing the economy, boosting competition and overhauling the jobs market, though he did not give details.

The measures will follow a 33 billion euro package of cuts and tax hikes aimed at balancing the budget by 2013 which was passed by parliament last week but which has been criticized for weighing too heavily on Italy's already sickly growth prospects.

Monti said he was aware that the austerity package had "many disadvantages" but said budget discipline was needed to restore confidence in Italy's public finances. However he added that European policy had to focus increasingly on growth.

"All mechanisms for making the application of this discipline more secure is welcome, provided it is integrated into a comprehensive European economic policy which has more resources to get the euro zone out of its current difficulties and above all promotes growth more," he said.

RECESSION

Italy's chronically weak economy over the past two decades has been one of the main factors in creating a debt burden that now amounts to around 120 percent of gross domestic product, second only to Greece in the euro zone.

Rigid labor rules - which give some workers iron-clad guarantees while forcing increasing numbers of young people to accept short term jobs with few prospects - an inefficient public sector, low productivity and choking red tape have long weighed on the economy.

Italy is widely considered to be heading for a severe recession next year and data on Thursday showed business confidence at its lowest for two years, with orders falling and the production outlook worsening.

Although he offered no firm timetable, Monti said the government would move quickly under pressure both from international partners and the bond markets.

"The timetable will be rapid. We aren't being permitted to work calmly," he said.

Underlining the pressure he faces, yields on 10-year bonds remained locked above 7 percent on the secondary market on Thursday, near the levels which forced Greece, Ireland and Portugal to seek an international bailout.

Italy sold 7 billion euros ($9 billion) of bonds at auction in thin holiday markets, just above the mid-point of its target range, but the yield on benchmark 10 year BTPs was 6.98 percent, not far from a euro lifetime record of 7.56 percent a month ago.

"Buying 10-year Italian bonds is a leap of faith which investors are prepared to take only at very high interest rates," said Nicholas Spiro of Spiro Sovereign Strategy. "There are simply too many risks and uncertainties surrounding Italy."

Its 3-year bonds sold more easily and their yield fell more than two percentage points at auction to 5.62 percent -- far below the euro era record of 7.89 percent that Italy paid to sell the same bond at the end of November. ($1 = 0.7724 euros)

(Additional reporting by Gavin Jones; writing by James Mackenzie; Editing by Ruth Pitchford)

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