Spain and Italy appealed to European policy makers to step up their response to the financial crisis after a 100 billion-euro ($125 billion) lifeline for Spanish banks failed to calm markets.

Spanish Prime Minister Mariano Rajoy said today he'll “battle” central bankers refusing to buy debt from peripheral nations. Rajoy published a letter to European Union leaders calling for the European Central Bank to buy debt from the countries struggling to shore up their finances.

“That is the battle we have to wage in Europe,” Rajoy told the Spanish parliament in Madrid today. “I am waging it.” His Italian counterpart, Mario Monti, told lawmakers in Rome Europe faces a “crucial” moment.

The leaders of southern Europe's biggest economies went on the offensive as bond yields jumped following the announcement of a bailout for Spanish banks that was intended to quell concern over the countries' finances. The decline wiped out the effects of 1 trillion euros in ECB loans for euro-region banks that had held yields in check since December.

Spain's 10-year yields declined 2 basis points today to 6.69 percent following a surge after the bailout. Italian bonds also strengthened after slumping the previous two days.

“The crisis will inevitably roll on to the next domino, and that's Italy,” James Nixon, chief European economist at Societe Generale SA in London, said in a telephone interview. “The southern European economies are effectively in free-fall and market appetite for southern European debt is rapidly drying up. I can't see anything to turn that dynamic around.”

Monti told lawmakers in the national parliament that the EU hasn't time to wait for austerity plans to stabilize borrowing costs and officials must act to support economic growth as the Italian economy slides deeper into recession.

The Italian economy shrank by 0.8 percent in the first quarter compared with 0.7 percent in the previous three months and a 0.3 percent contraction in Spain in the first quarter. Italy's borrowing costs surged at a sale of 6.5 billion euros of one-year Treasury bills yielding 3.972 percent. One-year paper paid 2.34 percent at the previous sale on May 11.

“Above all, Europe needs more growth,” said Monti, who will travel to Berlin today. The single currency area is “in a particularly intense and particularly crucial” situation.

Spiraling borrowing costs and shrinking output are opening divisions among EU leaders who face a series of hurdles in the coming days as bond investors question their ability to hold the euro area together. Italy is due to sell another 3 billion euros of bonds tomorrow while international consultants are due to report on the extent of Spanish banking losses by June 21.

Spain Deficits

The European Commission forecasts that Spain will post deficits of 6.4 percent of gross domestic product this year and 6.3 percent in 2013 even after unveiling 45 billion euros of spending cuts and tax increases. Rajoy's aim is a deficit of 5.3 percent of GDP this year.

Greeks will vote June 17 on whether to back Alexis Tsipras, who wants to scrap the austerity plan dictated by the EU and the International Monetary Fund as a condition of its bailout. New Democracy leader Antonis Samaras, who supports the bailout conditions, said backing Tsipras will see Greece effectively thrown out of the euro.

“The indirect impact of a Greek redenomination on banks throughout the eurozone could be severe, most notably in program countries as well as Spain and Italy,” Fitch Ratings said in a report today. “A robust response from policymakers would be required.”

Bundesbank board member Andreas Dombret this week said the ECB won't buy more government bonds to ease the market tensions while Swedish central bank governor Stefan Ingves today said it's hard to see what else the ECB could do for Spanish lenders.

“We have done our part,” Dombret said in a June 11 interview in London. “Now it's up to the political leaders to deliver on the fiscal and structural policy side.”

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Spain, Italy Appeal for More Action

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