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ROME, Sept 13 - Yields on Italian five year bonds hit their highest level since the introduction of the euro a decade ago after an auction on Tuesday which underlined mounting fears over the currency bloc's third largest economy.

Italy has been dependent on support from the European Central Bank to keep a lid on its borrowing costs for over a month but a surge in bond yields over the past week suggests that financial market sentiment has turned against Rome.

The Treasury sold a total of 6.485 billion euros worth of fixed rate BTP bonds, just under its maximum target of 7 billion euros, but was forced to pay a record yield of 5.60 percent on nearly 4 billion euros of five year paper.

The bid-to-cover ratio, an indicator of investor demand, fell to 1.279, well below the 1.93 on a previous auction of five-year paper.

The euro fell against the dollar after the results, which did nothing to allay concerns that the euro zone's crisis is still deepening and could spur another banking crisis.

Markets want to see decisive action and they want to see someone in control of the situation, said Marc Ostwald, a London-based analyst with Monument Securities.

Nothing that we've had, be it at a domestic level in Italy, be it at a pan euro zone level, or above all from Germany, indicates that anyone really is getting to grips with presenting euro zone policy with one voice.

The head of Italy's largest manufacturer, Fiat warned that the situation risked spiraling out of control.

I think there is a possibility, if the wrong steps are taken, that the system goes off the rails, Fiat chief executive Sergio Marchionne told reporters at the Frankfurt car show.

CHINA HELP?

Earlier, a Treasury spokesman confirmed that Italian Economy Minister Giulio Tremonti met Chinese officials last week, after the Financial Times reported that Rome had asked China to buy significant quantities of its debt.

The spokesman declined to comment on the substance of the meeting with a delegation that a second source said included the head of China Investment Corp Lou Jiwei and officials in charge of investment and fixed income. There were separate meetings with state investment agency Cassa Depositi e Prestiti.

However, similar reports that Beijing was buying peripheral euro zone bonds have not proved conclusive in the past.

It wouldn't be the first time the market had hoped that China would ride to the rescue, Jeremy Batstone-Carr, strategist at Charles Stanley, said. But the Chinese don't have a great track record. They participated in the Portugal bonds this year, and they lost money.

By mid-morning, yields on 10 year Italian BTPs had climbed to 5.7 percent, while the spread over benchmark German Bunds had widened to 404 basis points. Credit default swaps, an insurance-like instrument to hedge against debt default, hit a record spread of more than 500 bps on Monday.

The Financial Times said on its website that Italy had asked Beijing to make significant purchases of Italian debt. The Wall Street Journal reported Italy was hoping China would buy large amounts of debt.

Two weeks ago, Italian officials were in Beijing to meet CIC and China's State Administration of Foreign Exchange (SAFE), which manages the bulk of China's foreign exchange reserves, the FT said. CIC is a sovereign wealth fund managing $300 billion.

The Italian Treasury spokesman gave no indication that bond-buying was discussed.

VERBAL SUPPORT

With about a quarter of China's record foreign currency reserves of $3.2 trillion estimated by analysts to be held in euro assets, Chinese leaders have repeatedly voiced support for the debt-mired single currency area.

Asked to comment on reports of the meetings in Italy, a Chinese foreign ministry spokesman said China had confidence in Europe's ability to handle its debts.

Premier Wen Jiabao said earlier this month that China retained its confidence in the euro and Europe's economy but the region's governments need to ensure the security of Chinese investments there.

Italy has moved to the center of the euro zone debt crisis amid growing worries about the sustainability of its 1.9 trillion euro debt pile.

Only intervention by the European Central Bank to buy Italian bonds has kept borrowing costs under control in recent weeks but yields have climbed sharply over the past days, suggesting the intervention had done little to change market sentiment.

An Italian emergency could overwhelm existing euro zone bailout mechanisms, and under pressure from markets and the ECB, Rome has presented an austerity package that aims to balance the budget by 2013.

The deficit-cutting measures are expected to be approved by parliament this week but there are widespread fears they could further slow Italy's already fragile growth.

Prime Minister Silvio Berlusconi promised on Monday that the 54 billion euro package of measures would be approved quickly and without further changes, seeking to calm fears that Italy had lost the will to push through the unpopular plan.

(Additional Reporting by Kevin Yao in Beijing, Brian Gorman in London, editing by Mike Peacock/Patrick Graham)

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