Italy Moves Closer to National Unity Government

Italy follows Greece's lead, seeks respected technocrat to pilot economic reforms.

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ROME/ATHENS (Reuters) — Italy moved closer to a national unity government on Thursday, following Greece's lead in seeking a respected veteran technocrat to pilot painful economic reforms in an effort to avert a euro zone bond market meltdown.

After five days of chaotic haggling, former European Central Bank vice-president Lucas Papademos was appointed to head an interim crisis cabinet charged with saving Greece from default, bankruptcy and an exit from the euro zone.

In Rome, former European Commissioner Mario Monti emerged as favorite to replace Italian Prime Minister Silvio Berlusconi within days and lead an emergency government that would implement long delayed reforms of pensions, labor markets and business regulation.

[See a collection of political cartoons on the economy.]

A political source said Monti, 68, would meet President Giorgio Napolitano and lower house speaker Gianfranco Fini on Thursday night.

Italy's political and economic turmoil has spurred fears of a possible break-up of the euro zone with borrowing costs for Europe's third biggest economy at unsustainable levels and the 17-nation currency bloc unable to afford a bailout.

German Chancellor Angela Merkel, Europe's main paymaster, called for broad political support for reforms in Greece and said Italy was on the road to winning back confidence, but political clarity was still needed.

She dismissed talk of a possible shrinking of the currency area, saying: "We only have one goal, that is to bring about a stabilization of the euro zone in its current form."

European Union officials continued to dither and pass the buck on how best to fight the worsening sovereign debt crisis.

Three senior ECB policymakers rebuffed pressure from investors and world leaders to intervene massively as a lender of last resort on bond markets to shield Italy and Spain from rapidly spreading financial contagion.

[Berlusconi Resignation is the Silver Lining of the Euro Crisis]

"We have gone pretty far in what we can do but there is not much more that can be expected from us. It is now up to the governments," ECB governing council member Klaas Knot told the Dutch parliament.

Knot, the Dutch central bank chief, said bond-buying only had a temporary effect. The ECB has bought more than 180 billion euros of peripheral euro zone bonds and traders said it was active in the market again on Thursday, but the purchases have failed to lower borrowing costs durably.

Stepping up the scale of bond-buying would eventually force the ECB to start printing money with the risk of stoking inflation, which was why the EU treaty had excluded such action, Knot said.

ECB executive board member Peter Praet said it was not the task of the central bank to intervene "when there are fundamental doubts about the sustainability of some countries." Outgoing ECB chief economist Juergen Stark earlier rejected calls for the ECB to act as lender of last resort like the U.S. Federal Reserve or the Bank of England.

In Brussels, a euro zone official said there were no plans to use the bloc's 440-billion-euro ($600 billion) rescue fund to help Italy, even with a precautionary credit line.

"Financial assistance is not in the cards," the official said. A second official said: "The ECB will be drawn like every one else by the weight of gravity (to act).

MARKETS STEADIER

The euro rose from a one-month low on hopes that new governments being formed in Italy and Greece could help fend off a euro zone break-up.

[Berlusconi Will Resign, Italy's Fiscal Problems Remain]

Italian 10-year bond yields fell back below the red line of 7 percent from 7.6 percent on Wednesday, a level seen as unsustainable in the long term, amid signs that the political deadlock was easing. Rome paid less to sell 1-year treasury bills than many had feared.

President Giorgio Napolitano asked Monti, a respected economist whom he appointed a senator for life on Wednesday, to stay in Rome over the weekend and drop out of a conference he was due to chair in The Hague as moves to form a new government accelerated.