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German and French officials have discussed plans for a radical overhaul of the European Union that would involve setting up a more integrated and potentially smaller eurozone, EU sources say.

The claims come as soaring Italian borrowing costs saw global markets tumble overnight and policy makers outside the eurozone warned the crisis could spread.

And political deadlock continues in Greece and Italy, where talks have stalled to replace both countries' outgoing prime ministers.

EU sources say discussions among politicians in Paris, Berlin and Brussels raised the possibility of one or more countries leaving the zone, while the core pushes to deeper economic integration.

"France and Germany have had intense consultations on this issue over the last months, at all levels," a senior EU official in Brussels said, speaking on condition of anonymity because of the sensitivity of the discussions.

"We need to move very cautiously, but the truth is that we need to establish exactly the list of those who don't want to be part of the club and those who simply cannot be part."

French president Nicolas Sarkozy gave some flavour of his thinking on Tuesday, when he said a two-speed Europe - the eurozone moving ahead more rapidly than all 27 countries in the EU - was the only model for the future.

The change has been discussed on an "intellectual" level but had not moved to operational or technical discussions, the EU official said.

But European Commission president Jose Manuel Barroso issued a stern warning of the dangers of splitting the zone.

"There cannot be peace and prosperity in the north or in the west of Europe, if there is no peace and prosperity in the south or in the east," Mr Barroso said.

Politicians outside the euro area have kept up pressure for more decisive action to stop the crisis spreading.

Christine Lagarde, head of the International Monetary Fund, told a financial forum in Beijing that Europe's debt crisis risked plunging the global economy into a Japan-style "lost decade".

"If we do not act boldly and if we do not act together, the economy around the world runs the risk of downward spiral of uncertainty, financial instability and potential collapse of global demand," she said.

The dramatic escalation of the cost of Italian debt bonds to more than 7 per cent forced German chancellor Angela Merkel to issue a call to arms overnight.

Ms Merkel said Europe's plight was now so "unpleasant" that deep structural reforms were needed quickly, warning the rest of the world would not wait.

"That will mean more Europe, not less Europe," she told a conference in Berlin.

"It is time for a breakthrough to a new Europe.

"A community that says, regardless of what happens in the rest of the world, that it can never again change its ground rules, that community simply can't survive."

Italy has replaced Greece at the centre of the crisis and is on the cusp of needing a bailout that Europe cannot afford.

"Financial assistance is not in the cards," one eurozone official said, adding that the bloc was not even considering extending a precautionary credit line to Rome.

Meanwhile, having lost his majority in a parliamentary vote, Italian prime minister Silvio Berlusconi confirmed he would resign after implementing economic reforms demanded by the European Union, saying Italy must then hold an election in which he would not stand.

He opposed any form of transitional or unity government - which the opposition and many in the markets favour - and said polls were not likely until February, leaving a three-month policy vacuum in which markets could create havoc.

Even with the exit of a man who came to symbolise scandal and empty promises, it will not be easy for Italy to convince markets it can cut its huge debt, liberalise the labour market, attack tax evasion and boost productivity.

And with the markets' fire turned firmly on Italy, Greece's struggle to find a new prime minister became something of a sideshow, but one which demonstrated the difficulty in taking decisive action anywhere within the eurozone.

Greek prime minister George Papandreou said he was stepping down without saying who would succeed him as the nation heads towards bankruptcy.

Reports have named veteran socialist Filippos Petsalnikos and former banker Lucas Papademos as possible replacements.
Video: Look back at Berlusconi's colourful career (ABC News)

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