The European Commission yesterday warned that the euro zone faces a "deep, prolonged" recession if the financial crises besetting the currency bloc are not solved swiftly.
"Growth has stalled in Europe and there is a risk of a new recession," said Olli Rehn, the commission's vice president for economic and monetary affairs.
The stark warning came as the commission slashed its growth forecast for the euro zone next year by more than a percentage point.
Expected economic growth in the euro zone would drop to 0.5 per cent next year, down from 1.5 per cent this year, it said in its twice-yearly economic forecast. Growth would increase to 1.3 per cent in 2013.
The economy would contract 0.1 per cent in the final three months of the year compared with the previous quarter, with zero growth quarter on quarter in the first three months of next year.
The gloomy warning helped to ensure markets remained rocky, dampening investor hopes of a breakthrough in resolving the debt crisis. The benchmark Stoxx Europe 600 Index added 0.38 per cent to 237.24 during afternoon trading.
Italy's borrowing costs eased slightly as reports suggested the European Central Bank (ECB) bought the country's debt.
Italy sold Ä5 billion (Dh24.99bn) of one-year bills at an average of 6.087 per cent, the highest in 14 years.
In early trading, the yield on the Italian 10-year note was up 15 basis points to 7.4 per cent, still close to record euro-zone highs.
The ECB bought Italian government bonds, according to three people familiar with the matter, Bloomberg News reported.
Fears are mounting of a possible Italian default on its debt, worsened by uncertainty about the country's political leadership.
Silvio Berlusconi on Tuesday announced he would resign as prime minister once parliament passed urgent reforms, in votes expected this month.
Christine Lagarde, the managing director of the IMF, urged Italy to act quickly to fill the political vacuum.
"No one exactly understands who is going to come out as the leader. That confusion is particularly conducive to volatility," she told a press conference in Beijing yesterday.
Greece, another troubled euro-zone economy, helped remove uncertainty surrounding its own political leadership with the naming yesterday of Lucas Papademos as the country's prime minister.
The former ECB vice president will replace George Papandreou, who said he would step down as prime minister.
Signs that the euro-zone debt crisis may be starting to hurt China, the world's second-biggest economy, also emerged yesterday.
The country's exports rose at the slowest pace in almost two years last month as the euro-zone crisis dented demand. Overseas shipments rose 15.9 per cent from a year earlier, customs bureau data showed.
"The tumultuous events in the euro zone are weighing heavily on China's exports," Alistair Thornton, an analyst at IHS Global Insight, said in a report.
Export weakness may heap pressure on China's government to reverse interest rate increases and other curbs imposed to control its runaway economy.
The export growth slowdown caused Asian markets to slow. Japan's Nikkei 225 index fell 2.4 per cent to 8,549.94, Hong Kong's Hang Seng dropped 4.4 per cent to 19,127.04 and South Korea's Kospi slid 3.4 per cent to 1,842.80.
* with Bloomberg News and Reuters