An awful Italian bond auction and the prospect of no European Central Bank (ECB) intervention has sent investor sentiment down further this morning.

Italy was forced to pay a record high yield of 6.5 per cent for six-month bonds, which caused two-year bond yields to reach close to 8 per cent.

With ten-year yields around 7.4 per cent, Italian bond yields have formed an inverted yield curve, with short term yields higher than long-term.

This sort of inverted curve indicates that investors believe there is short term danger, such as a default, with less risk in the long term if the country rides it out.

The inverted curve has previously been seen in bonds from Greece, Portugal and Ireland, which have all required a bailout.

Kathleen Brooks, research director at Forex.com, pointed out that as Italian six-month yields had risen from 3.5 per cent at the end of October, ‘In a matter of three weeks Italy’s credit worthiness has sunk to desperate levels’.

She said, ‘This is clearly an unsustainable situation and Italy won’t be able to afford to sell debt at this level. Its next bond auction is Monday and then one on Tuesday. Added to that Italy has to auction €22 billion of debt in December, so it could be an explosive end to the year.’

The gloomy outlook was exacerbated yesterday when Eurozone leaders quashed any hopes of large-scale ECB intervention to solve the sovereign debt crisis.

Germany had been firmly against expanding the ECB’s remit to buy up government bonds, or to issue so-called ‘Eurobonds’ and, in a joint press conference, the leaders of the three biggest Eurozone economies, Germany, France and Italy, outlined plans instead for European treaty changes designed to bring about closer fiscal union.

However, such changes have historically taken a long time to be ratified by all the EU states, and the impatient markets were looking for a more immediate solution.

Brooks predicted that there may be further failed bond auctions, following the German failure yesterday, without a short term or long term solution in place.

She said, ‘For as long as the ECB remains on the sidelines and the currency bloc’s high command fail to instill confidence that it has a workable solution to the crisis then there will be a buyers strike.’