MADRID—Fear, that contagious emotion, spread from country to country in Europe on Thursday as panicky investors worried the euro currency union could be heading toward an ugly breakup.
Spain and even France, one of the continent's core economic engines, were forced to pay sharply higher interest rates to raise cash to fund government spending.
While the European Central Bank was suspected of intervening in bond markets to fight the rise in the borrowing rates, many analysts say it needs to act more aggressively to contain the crisis. But Germany, Europe's paymaster, once again blocked any such move on concerns it would let profligate governments off the hook.
Uncertainty is now even eroding the appeal of top AAA-rated government bonds from countries like France as investors prepare for worst-case scenarios like the deconstruction of the eurozone.
"Basically, if you look at any country that is not Germany, the contagion effect is major," said Oscar Moreno of Madrid brokerage house Renta4.
In Spain, an auction of 10-year government bonds left the country paying interest rates of nearly 7 percent. That's the highest rate since 1997 and a level that economists see as unsustainable. Greece and Ireland received rescue loans from the European Union after their bond yields jumped above the same level.
Across the border, France had to pay 1.85 percent to sell two-year bonds, up from 1.31 percent at the last auction in October.
The dismal figures were the symptom of a broad retreat by investors this week from European stock and bond markets as they worry eurozone leaders are no closer to finding a lasting solution. Shares of European companies fell in all of the continent's exchanges, including so-called safe nations like Germany and the Netherlands.
In the U.S., stock indexes were down as the spiking bond yields in Spain overshadowed the latest signs of growth in the U.S. economy. The Dow Jones industrial average dropped 135 points, or 1 percent, to close at 11,771.
German Chancellor Angela Merkel added to the market carnage by shrugging aside hopes for a quick-fix solution to the crisis. She insisted that spreading debt liability with a massive European Central Bank bond-buying drive could ruin competitiveness and won't resolve Europe's problems.
The ECB already buys government bonds in relatively small quantities -- euro4.5 billion ($6 billion) last week -- to keep their yields down. A bond's yield is an indication of the rate the government would pay to raise money on markets.
Analysts said ECB bond purchases helped bring Italy's 10-year yield back below the 7 percent level on Thursday. But the program is far too small to make a lasting impact in bond markets.
The ECB's leaders say the bond purchases must remain limited and temporary to avoid giving governments the sense that they can delay much-needed reforms to make their economies more competitive.
Another move experts say could provide a decisive solution to the crisis is the introduction of "eurobonds" issued jointly by financially strong countries and weaker ones.
But Merkel rejected that as well, for fear of exposing German taxpayers to huge costs. She insisted Thursday that Europe needs to consider growth-promoting measures that don't immediately cost money, such as labor-market reforms that could take months to enact.
The fear, however, is that during that time the financial jitters will spread and worsen, pulling the currency union apart.
"Chances are remote that investors will wake up one morning to find that a master-plan has been put in place to preserve the euro arrangements and to restore stability to the zone," Stephen Lewis of London's Monument Securities said in a note to clients. "It is more realistic to expect one or more of the present member-states, whether voluntarily or otherwise, to quit the euro zone."
Europe's slow and indecisive actions to fight the debt crisis have allowed uncertainty to fester in financial markets. That has darkened the economic outlook at a time when governments badly need growth to lower their debts. Spain's unemployment rate, for example, is a staggering 21.5 percent and the eurozone economy stalled in the third quarter and is likely to fall into another recession.
The toxic combination of low growth and high debt is pushing investors to reassess the risk inherent in owning European government bonds, even of traditionally strong countries like France and the Netherlands. As economic forecasts worsen, investors lower their expectations of countries' ability to repay their debts.
The weakest countries, such as Greece, got hit first and hardest. But it didn't take long for an economy like Italy's -- traditionally stable, but with high debt and weak growth -- to lose traders' trust. As some investors price in worst-case scenarios like the breakup of the euro currency union, some are even moving out of AAA-rated sovereign bonds like those of France.
Spanish Finance Minister Elena Salgado accused investors of unfairly punishing Spain because its overall debt load of about 70 percent is manageable and sustainable "beyond any doubt."
But in trying to defend Spain, she also acknowledged that 12 of the 17 countries that use the euro are seeing their borrowing costs rise.
"We are seeing systematic attacks on our sovereign debt," Salgado told Cadena Ser radio in an interview. "Today it is Spain, yesterday it was Italy, the day before that it could have been Belgium, and tomorrow it could be any other country."
The financial chaos has rattled governments -- new governments of technical experts were installed in Athens and Rome this month, while a center-right government is expected to take over in Madrid on Sunday -- and caused social unrest.
As Italy's new Premier Mario Monti unveiled new economic reforms on Thursday, riot police clashed with anti-austerity protesters in Milan.
"The end of the euro would cause the disintegration of the united market," the former European Union competition commissioner told the Senate ahead of a confidence vote on his one-day-old government.
While high borrowing rates of 7 percent do not spell imminent collapse for a country, they are clearly unsustainable over several months.
Spain and other European countries like Italy "cannot survive for too long with these interest rates," warned Juan Pedro Zamora of X-trade brokers in Madrid.
While Spanish opposition leader Mariano Rajoy and his conservative Popular Party are expected to win in a landslide in Sunday's elections, analysts said any austerity measures they push through probably won't be enough on their own to ease increasing investor aversion to the continent.
"What we need is for the European Union to finally push for an economic and monetary union in which countries would be automatically penalized if they exceed the public deficit and in which the economic policies of each country would be based on those of the European Central Bank," Zamora told Spanish National Radio.
Investors are skeptical politicians can agree to that close of a financial union anytime soon, translating into more financial havoc ahead for much of Europe.
Daniel Woolls and Ciaran Giles in Madrid, Geir Moulson in Berlin and Frances D'Emilio in Rome contributed to this report.