Italian borrowing costs reached breaking point today after prime minister Silvio Berlusconi's promise to resign failed to raise optimism about the country's ability to deliver on long-promised economic reforms.

Markets showed little or no relief that a man they saw as an obstacle to economic reform planned to leave office. The yield on Italy's 10-year benchmark bonds rose sharply to 7.404 per cent, the highest since the euro was founded in 1999 and over the 7 per cent level widely seen as unsustainable at which Portugal, Greece and Ireland were forced to seek a bailout.

The yield on Italy's five-year note jumped 72 basis points to 7.60 per cent. By contrast, Germany's implied cost of borrowing for 10 years is 1.73 per cent.

The chaos in Italy also dragged on the euro, which fell as low as $1.3553, the weakest since October 10h.

Having lost his majority in a key parliamentary vote, Mr Berlusconi confirmed last night he would resign after implementing urgent economic reforms demanded by the European Union, and said Italy must then hold an election, in which he would not stand.

Mr Berlusconi was largely seen as an obstacle to pulling Italy, which is the euro zone’s third-largest economy and has debts worth 120 per cent of national income, from a financial mire.

In an attempt to reassure markets, Italy’s president Giorgio Napolitano said this evening that Mr Berlusconi will definitely resign and the country will either have a new government or early elections soon.

Mr Napolitano said concerns about whether Mr Berlusconi would actually leave office are completely unfounded. He said economic reforms demanded by the EU would be passed by parliament “in a matter of days” and that he would work to avoid a prolonged period of political uncertainty.

Italy's Chamber of Deputies will give final approval to the planned austerity measures by Sunday, the Ansa news agency reported, citing Gianfranco Fini, speaker of the house.

It is likely to take the combined forces of the European Central Bank, the IMF and the euro zone bailout fund to break Italy's financial fall, and it's far from clear that Europe's leaders are ready to take on that rescue mission.

The precondition for Rome would be to rapidly replace Mr Berlusconi with an internationally respected figure and adopt long-delayed structural reforms.

That might spur the currency bloc's leaders, who euro zone officials say have no plans for Italy's rescue even though its borrowing costs have risen sharply to levels that threaten its ability to raise funds on the market.

"Financial assistance is not in the cards," one euro zone official said today, adding the euro zone was not even considering extending a precautionary credit line to Rome.

It may already be too late. Many analysts say the Italian bond sell-off has already gone past a point of no return which will lead to the break up of the currency bloc.

"If you allow Italy to fail you bring down the euro zone," said Nicholas Spiro, head of debt consultancy Spiro Sovereign Strategy.

A euro zone without tiny countries like Greece or Portugal may be plausible, but for many it is inconceivable without the region's third largest economy, a founding member of the group that evolved into the European Union.

Mr Berlusconi today said he opposed any form of transitional or unity government - which the opposition and many in the markets favour - and said polls were not likely until February, leaving a three-month policy vacuum in which markets could create havoc.

Mr Berlusconi, who has already reluctantly conceded that the IMF can oversee Italian reform efforts, said Angelino Alfano, head of his governing People of Liberty party, is in "pole position" to succeed him.

As the euro weakened 1.7 per cent to $1.3605,

German chancellor Angela 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.

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 stayed more loosely connected - a signal that some members may have to quit the euro. Portugal and Ireland were forced to seek EU-IMF bailouts when their borrowing costs reached similar levels.

The European Central Bank, the only effective bulwark against market attacks, wasted no time intervening to buy Italian bonds, traders said. "The ECB is buying in decent sizes," a London hedge fund investor said. "It makes you wonder how much firepower it has. It's scary. The market was a bit naive when Berlusconi left. Now it realises there's a mountain to climb."

"It is a step in the right direction," Swedish finance minister Anders Borg said today when asked about Mr Berlusconi's plan to resign. "There has been no proper understanding of the problems being faced in Italy."

Even with the exit of a man who came to symbolise scandal and empty promises, it will not be easy for Italy to convince markets it can cut its huge debt, liberalise the labour market, attack tax evasion and boost productivity.

Policymakers outside the euro area kept up pressure for more decisive action to stop the crisis spreading.

International Monetary Fund managing director Christine Lagarde told a financial forum in Beijing that Europe's debt crisis risked plunging the global economy into a Japan-style "lost decade" and said it was up to rich nations to shoulder the burden of restoring growth and confidence.

"Our sense is that if we do not act boldly and if we do not act together, the economy around the world runs the risk of downward spiral of uncertainty, financial instability and potential collapse of global demand ... we could run the risk of what some commentators are already calling the lost decade."

Euro zone finance ministers agreed on Monday on a roadmap for leveraging the euro zone’s €440-billion rescue fund to shield larger economies like Italy and Spain from a possible Greek default.

But there are doubts about the efficacy of those complex plans, and with Italy's debt totalling some €1.9 trillion, even a larger bailout fund could struggle to cope.

Ms Lagarde said she was hopeful the technical details on boosting the European Financial Stability Fund (EFSF) to some €1 trillion would be ready by December.

Many outside Europe are calling on the ECB to take a more active role as other major central banks do in acting as lender of last resort. German opposition to that remains implacable, seeing it as a threat to the central bank's independence.

German central bank chief Jens Weidmann, a key member of the ECB, rejected a separate proposal to use national gold and currency reserves or IMF special drawing rights to boost the bailout fund, welcoming opposition from Dr Merkel to the same. But with the ECB just about the only buyer of Italian bonds, according to traders, it may have to act more aggressively to contain the latest wave of crisis, despite internal opposition to its bond-buying programme.

It could call on limitless power if it began printing money as the Federal Reserve and Bank of England have. But for it, and Berlin, that is a step too far.

Agencies