By Catherine Hornby
ROME (Reuters) - High borrowing costs are dangerous for Italy and Spain and the EU must tackle them quickly by establishing a system that supports countries which are making reforms, OECD Secretary General Angel Gurria said in an interview on Wednesday.
Gurria said the European Stability Mechanism rescue fund, or ESM, needed to become operational as soon as possible so it could start intervening on bond markets, and that it should be strengthened to send a clear signal to markets.
"We are now facing pressures on Italy and Spain which are very dangerous if we do not tackle them immediately," Gurria said. "They are doing all their homework ... yet we still don't have a system that supports or rewards virtues, good policies that actually protect countries that are doing the right things."
Spanish yields temporarily breached the 7 percent level widely seen as unsustainable in recent days and Italian yields are hovering close to 6 percent, although both countries' borrowing costs eased on Wednesday after Spain unveiled new austerity measures.
Italian Prime Minister Mario Monti, who is under intense market pressure to shape up his economy and avoid being drawn into the center of the debt crisis, said on Wednesday that the economic reforms undertaken by his government would bear fruit eventually.
"I would not want anyone to consider that the war Italy is fighting is over, but I think we can reasonably hope to see the first results in some aspects next year," Monti told the annual meeting of banking association ABI.
Gurria praised efforts in Italy and Spain to reform the labor market and to rein in public finances, but said it was up to European Union institutions to act swiftly to restore confidence in the euro zone.
EU leaders agreed at an end-June summit to allow the bloc's rescue funds to stabilize bond markets by intervening directly. But there has been some backtracking on the plan, with Finland and the Netherlands voicing opposition.
The ESM bailout fund was originally meant to start on July 1, then on July 9, but it has been held up after Germany's top court said on Tuesday it would examine whether the bailout fund and new budget rules are compatible with national law. The court gave no date for its verdict, which could influence how much deeper European integration can go.
Without German backing, the ESM cannot come into effect, a state of affairs that could quickly see several heavily indebted euro zone states pushed into insolvency.
Gurria said the European Central Bank should be the main instrument for market intervention, whether directly or indirectly, but that Europe should be using all its institutions "to the full hilt".
The ECB has resisted pressure to revive its bond buying program -- dormant for four months now -- and other non-standard measures such as the cheap three-year loans it made to banks in December and February, arguing that it is up to governments to resolve the crisis.
Gurria said Europe has had to pay a high price for uncertainty and delaying decisions, but that he felt it would come through the crisis as a better union.
"The silver lining of the crisis is that Europe is strengthening its institutions and covering the gaps it left behind, so eventually it will be stronger." he said. "In the meantime it will be a bumpy road."
(Editing by Catherine Evans)