ITALY'S economy is teetering on the brink of collapse today after the cost of its borrowing hit an unsustainable level.

Fears of contagion led the International Monetary Fund (IMF) to warn that without swift and bold action the world could be facing a collapse in demand and a “lost decade”.

The announced departure of Prime Minister Silvio Berlusconi, intended to calm markets, failed to do so as markets continued to lose confidence that Italy, with £1.6 trillion of debt, is able to implement measures to overcome its financial crisis.

In a dramatic escalation of the eurozone debt crisis, Italian 10-year borrowing rates shot above 7%, the level that is widely deemed unsustainable. One-year debt yields topped 8%. Consequently, shares suffered another tumble, with the Dow Jones falling by more than 3%.

Last night, Italian ministers were planning to expedite an austerity package of tax hikes and spending cuts by passing it as early as Saturday in order to instil some confidence that Italy can get a grip on its finances.

This could also result in Mr Berlusconi standing down before Monday and a unity coalition being formed next week, rather than protracted elections.

The fear across Europe and beyond is that the problems in Greece and now Italy will become contagious and spread elsewhere, deepening a lack of confidence and increasing instability that will lead to a second global downturn.

At Westminster, David Cameron told MPs that eurozone leaders urgently needed to put “flesh on the bones” of their bailout deal to stop the contagion of bad debt spreading.

The Prime Minister said: “If you don’t have credibility about your plans to deal with your debts and deal with your deficits, whether you like the markets or not, they won’t lend you any money. That’s what we are seeing in countries like Greece, and now tragically Italy, where the price of borrowing money is getting to a totally unsustainable level. It’s a lesson for all of us to have sustainable plans to get on top of our debt and our deficits.”

In Berlin, Chancellor Angela Merkel said Europe’s plight was now so “unpleasant” that deep structural reforms were needed quickly, as the rest of the world would not wait. “That will mean more Europe, not less Europe,” she said. “It is time for a breakthrough to a new Europe.”

Unlike Greece, an Italian default would threaten the entire euro project. EU treaty changes could take a year or more, yet Rome does not have that much time.

In Brussels, eurozone officials said they had no plans for a financial rescue package for Italy, seen as too big to bail out. “Financial assistance is not on the cards,” said one official.

Meantime, policy-makers outside the eurozone kept up pressure for more decisive action to stop the crisis spreading.

Christine Lagarde, head of the IMF, said: “Our sense is that if we do not act boldly and if we do not act together, the economy around the world runs the risk of a downward spiral of uncertainty, financial instability and potential collapse of global demand. We could run the risk of what some commentators are already calling the lost decade.”

Meanwhile, Greece’s political vacuum continued as George Papandreou announced he was stepping down as Prime Minister, but there was no agreement on who would replace him. Political leaders will meet this morning to find a successor.