By NEELABH CHATURVEDI and NICK CAWLEY

· MARKETS

· NOVEMBER 1, 2011, 9:37 A.M. ET

Bond Markets Tank

By NEELABH CHATURVEDI And NICK CAWLEY

LONDON—Greek Prime Minister George Papandreou's call for a referendum on the country's second bailout package has badly shaken Europe's weaker government bond markets Tuesday, pushing yields on 10-year Italian bonds perilously close to their highest levels since the inception of the euro.

Yields on Italian bonds rose sharply with the 10-year Italian bond yield increasing by 0.13 percentage point to 6.3%, just under its euro-era record of 6.4%. The yield on the five-year bond hit a euro-era high of 6.07%, 0.19 percentage point higher on the day, despite what traders said was continued buying of bonds by the European Central Bank. (THE ECB MONETIZING ITALIAN DEBT!!!!!!)

The extra yield demanded by investors to hold 10-year Italian government bonds instead of safe-haven German bunds widened to a euro-era record of 4.39 percentage points. THIS IS THE ALL IMPORTANT SPREAD - WHAT A GREAT SIGNAL - REAL TIME AND TOTALLY ACCURATE - NOW THAT IS A SIGNAL - NO WONDER WHY POLICY MAKERS CONSTANTLY LOOK AT SPREADS FOR CLUES AS TO THE SENTIMENT OUT THERE!

The rise in yields worries investors, who have seen Greece, Ireland and Portugal forced to apply for bailouts after their borrowing costs reached these levels, which markets consider unsustainable for government borrowers to support over the longer term.

The move by Mr. Papandreou, which caught markets by surprise, fanned concerns among some participants that Greece could leave the euro zone. REMEMBER, IT IS SURPRISES THE DRIVE THE MARKET AND THIS SURPRISE WAS NOT GOOD FOR THE WEAKER BOND MARKETS BUT GREAT FOR STRONGER BOND MARKETS (i.e., US and Germany - more on this below)

"The prime minister will be hoping for a vote in favor to strengthen his mandate, but if the Greek population votes against, it will leave the International Monetary Fund and Greece's European partners in a very difficult situation and seriously increases the risk of an exit from the currency union," said Gary Jenkins, head of fixed income at Evolution Securities. TALK ABOUT GOING 'ALL IN.' MAYBE DEEP DOWN, HE AND THE REST OF GREECE DO WANT TO SAY 'GOODBYE' TO THE EURO??? THE SOCIAL UNREST IN GREECE IS IMMENSE.

The referendum is likely to take place in January, but before then, the government needs to survive a confidence vote on Friday. SO FRIDAY IS THE BIG DAY - WHEN WILL MARKETS REFLECT WHAT IS EXPECTED TO HAPPEN ON FRIDAY???

Risky assets, such as equities, extended their slide from Monday, which had stemmed from the lack of clarity on the broad-brush proposals announced following last week's European Union summit.

The December bund futures contract surged by over two points to 137.61 while the yield on the benchmark 10-year bund fell by 0.21 percentage point to 1.82%. THIS IS THE RALLY IN THE SAFER BOND MARKETS - US TREASURIES RALLIED AS WELL!

In European trade, the single currency fell as low as $1.3671 against the dollar and £0.8565 against sterling as risky bets were taken off the table. Banking stocks led European stock markets sharply lower. The benchmark Stoxx Europe 50 index fell 5% to 2267.73.

Italy remained firmly in the market's firing line as "concerns over the Italian authorities' resolve to carry out the structural reforms announced at the EU summit last Wednesday THIS IS IMPORTANT - IF PEOPLE BELIEVE THERE IS NO RESOLVE THEN THE REFORMS HAVE NO BITE! [especially those designed to lift the economy's disappointing per capita growth rate] are widespread," Goldman Sachs said in a note to its customers.

"Ongoing peer pressure from Italy's euro-area partners, alongside the ECB's ambivalent support in the secondary bond market, have left private buyers very wary to bear Italian credit risk."

European leaders last week reached an agreement with banks on the writedowns investors holding Greek bonds will bear to help bring down Greece's debt levels.

Greece is also due to receive €100 billion ($139 billion) in aid over the next three years.

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