The euro zone debt crisis moved into dangerous new waters today as Italy’s borrowing costs hit “unsustainable” levels.

The FTSE 100 Index was 2 per cent lower as Italian 10-year bonds soared past the 7 per cent mark - matching the levels which pushed Ireland and Portugal into multibillion bailouts from the EU and IMF.

The rise - a sign that investors have lost confidence in the country’s creaking finances - came despite prime minister Silvio Berlusconi vowing to resign after key budget reforms are passed.

Elsewhere, the uncertainty on the continent was fuelled when Greek prime minister George Papandreou formally announced his resignation - but failed to name his successor.

“While Italy is considered to be too big to fail, she may be too big to save unless there is a major change of attitude towards resolving the crisis,” said John Higgins, senior markets economist at Capital Economics. “Things could be about to turn very ugly.”

The ongoing uncertainty in Europe continued to weigh on the UK banking sector, which is exposed to £10.9 billion worth of Italian debt, with shares in Barclays falling nearly 10 per cent.

Mr Berlusconi has confirmed he will not run again for office and his hand-picked successor Angelino Alfano will be his party’s candidate when Italy holds new elections.

The markets initially posted modest gains after the move, which bolstered hopes for co-ordinated action on the debt-laden country’s austerity drive.

Mr Berlusconi was largely seen as an obstacle to pulling Italy, which is the euro zone’s third-largest economy and has debts worth 120 per cent of national income, from a financial mire.

But the uncertainty over when the election will take place and any policy the new government may adopt troubled investors - with the Cac-40 in France and Germany’s Dax dropping more than 2 per cent.

Meanwhile, troubles in Greece continued to weigh on the markets after Mr Papandreou, who stepped down amid increased criticism over his handling of his country’s part in the crisis, failed to unveil his replacement.

The embattled leader instead offered reassurance that the new interim government will seek to defend Greece’s debt deal and the country’s place in the euro.

The wider FTSE 100 Index was also weighed down by weak corporate results, with insurer Admiral plunging 28 per cent after it said higher-than-normal levels of personal injury claims were likely to dent its profits growth.

Banking giant HSBC fell more than 4 per cent after a slide in investment banking revenues knocked its underlying third-quarter profits.