Italy is auctioning as much as 7 billion euros ($10 billion) of bonds Tuesday, one day after borrowing costs surged at a bill auction, as Greece’s slide toward default roils global markets.

The treasury is selling 4 billion euros of a new benchmark five-year bond, after 10-year yields climbed to a five- week high of 5.571 percent. Investors charged Italy 4.153 percent Monday in a one-year bill offering, up from 2.959 percent a month ago.

“It’s rather unfortunate that the Italian auction is taking place when the market is in a panic mode,” said Fabrizio Fiorini, the head of fixed income at Aletti Gestielle SGR SpA in Milan. “Borrowing costs are likely to remain at elevated levels. The rise in Italian yields is manifestation of a lack of market confidence in European leaders’ ability to tackle the problem.”

A debt of 1.9 trillion euros -- more than Spain, Greece, Ireland and Portugal combined -- leaves Italy vulnerable to any advance in borrowing costs as it refinances maturing debt. The sales, which also include as much as 3 billion euros of bonds due in 2018 and 2020, will help fund 14.5 billion euros of debt scheduled for repayment on Sept. 15.

Italian officials have held talks with Chinese counterparts about potential investments in the euro region’s third-largest economy, an Italian government official said late Monday. The purchase of Italian bonds by China wasn't the focus of the talks, which took place in the past few weeks, the official said on condition of anonymity. A spokesman for Italian Finance Minister Giulio Tremonti declined to comment.

The Financial Times earlier reported that Italy aims to sell "significant'' quantities of bonds and stakes in strategic companies to China.

Default Risk

Divisions among European leaders on aiding Greece and preventing Italy from being engulfed by the debt crisis is sapping demand for bonds in the region. In Greece, Prime Minister George Papandreou’s latest offer of increased austerity is failing to convince investors the country can meet its fiscal targets and avoid default.

The yield on Greece’s two-year note Monday surged to almost 70 percent, while the cost of insuring Greek, French, Spanish and Italian debt against default all rose to records. The premium investors demand to hold Italian 10-year bonds rather than comparable German bunds rose to 383 basis points, nearing a euro-era record close of 389.5 set on Aug. 4.

European stocks slumped, dragged lower by a slide in shares of banks who are the biggest holders of Greek and Italian bonds. UniCredit SpA, Italy’s largest bank, fell 11 percent to 69 euro cents, the biggest decline and lowest close since March 2009. Intesa Sanpaolo SpA fell 9.5 percent to close at the lowest in more than 14 years.

Funding Needs

“The contagion impact of a default will be severe, because next in the firing line will be Italy, Spain, and it will take in the whole of the European banking sector too,” Suki Mann, a strategist at Societe Generale SA in London, wrote in a report.

While Italy has completed more than 70 percent of its debt financing this year, it still needs to sell about 70 billion euros of bonds by year-end to cover its budget deficit and other redemptions.

Italian yields are at their highest since the European Central Bank started buying Italian bonds on Aug. 8. To secure the ECB backstop, Prime Minister Silvio Berlusconi rushed through a 54 billion-euro austerity package that faces final approval from the lower house of parliament as soon as Wednesday.

Berlusconi’s allies began watering down the bill soon after it was first approved by the Cabinet on Aug. 12 and the backslide triggered an 11-day slump in Italian bonds that ended Sept. 6. One day before the Senate was set to vote on the plan, the government added a one-percentage point increase in the value added tax to compensate for a raft of measures that had been dropped from the original plan.

Premier's Plan

Berlusconi said Monday that he had “performed a miracle” by delivering the deficit package just four days after the ECB called for the measures in exchange for buying the country’s bonds. Berlusconi travels to Brussels and Strasbourg Tuesday to defend the plan to EU Commission President Jose Manuel Barroso and EU President Herman Van Rompuy.

“The prospect of the budget approval, which should otherwise benefit Italy’s bonds, can’t offset the negative effect of the uncertainties over the outcome of the euro crisis,” said Chiara Cremonesi, a fixed-income strategist at UniCredit Research in London.