LONDON (Reuters) - The euro zone debt crisis kicked into a new gear on Wednesday as Italian bond yields soared into levels widely deemed unsustainable, causing a sharp sell-off in stocks and the euro.

Wall Street also looked set to open lower as fears about Italy, the world's eighth-largest economy, spread.

Yields on 2-year and 10-year Italian bonds rose above 7 percent. The curve measuring the yields inverted for the first time in the euro era -- a clear signal of rising concern among investors that they may not get their money back.

The moves came despite pledges by Prime Minister Silvio Berlusconi that he will resign after parliament passes budget reforms. His often controversial presence at the top has been viewed by many in the markets as a block to fiscal reform.

The mere fact that Italian 10-year bond yields have hit the all important 7 percent level shows that the crisis will not end simply with Berlusconi's excruciatingly slow demise, said Joshua Raymond, chief market strategist at City Index.

Investors were also keeping an eye on Greece, which was struggling to create a consensus government under a new, yet-to-be-agreed prime minister.

A plan for former European Central Bank vice-president Lucas Papademos to lead a Greek government of national unity has run into trouble, party sources said on Wednesday, prolonging political hiatus as the country heads toward bankruptcy.

World stocks as measured by MSCI were down 0.8 percent, while in Europe the FTSEurofirst 300 lost 2.2 percent.

DEBT DEBACLE

Core German debt yields fell to around 1.7 percent on 10-year paper in the rush to relative safety in the euro bloc's two-year-old debt crisis.

There is no guarantee (Berlusconi's) successor will be able to do a better job. Just keep your eyes on the Italian yield for now, said Christian Jimenez, fund manager and president of Diamant Bleu Gestion.

Yields on 10-year Italian bonds were nearly at 7.5 percent as were 2-year bonds.

The euro fell around 1.4 percent to $1.364, down from $1.3773 late in New York and well off a 2-month high of $1.4248 hit on October 27.

(Additional reporting by Marius Zaharia and Jon Hopkins, editing by Anna Willard/Ruth Pitchford)

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