Fears that Italy will be forced to seek a bailout sent Italian government bonds falling on Monday, as Europe's most senior finance ministers gathered to discuss the ongoing eurozone debt crisis.

The euro dropped sharply, as City traders and analysts warned that Italy could be close to becoming the fourth member of the eurozone to require financial help. The concern was shared in Europe's stock markets, with the FTSE 100 falling 65 points by lunchtime.

The yield, or interest rate, on an Italian 10-year government bond jumped to 5.4%, closer to the 7% level which is generally seen as unsustainable.

"What will really concentrate the mind of the finance ministers will be the recent upward trend in Italian government bond yields," said Gary Jenkins, head of fixed income research at Evolution Securities. "What would keep me awake at night if I was a European finance minister is that we are only about 2% away from a potential disaster scenario."

European Council president Herman Van Rompuy was scheduled to meet ECB president Jean-Claude Trichet, EU commission president José Manuel Barroso, EU commissioner Olli Rehn and Luxembourg's Jean-Claude Juncker, who chairs the group of eurozone finance ministers, at 11am BST to discuss the crisis.

Clouds have been gathering over Italy since Friday, when shares in several Italian banks fell sharply over concerns that they would fail the next round of EU stress tests. Economists have warned that the eurozone lacks the firepower to fund a bailout of Italy. German newspaper Die Welt reported on Monday that the European Central Bank is considering doubling its existing stabilisation mechanism to €1.5trn.

"We are seeing contagion spreading to Italy. The bailout facility as it stands would be nowhere near big enough to deal with Italy," Adam Cole, head of global currency strategy at Royal Bank of Canada Europe, told Bloomberg.

The Italian blue-chip index, the FTSE MIB index, fell by 3.25%, while the Spanish Ibex lost 2.8%. Traders in London said the eurozone crisis was dominating attention again, with the FTSE 100 down 1.25% or 65 points at 5924.

"The risk is that we may well have already seen the best of the stock market strength for the moment," said Yusuf Heusen, senior sales trader at IG Index.

The euro lost almost two cents against the dollar, trading around $1.4035.

The cost of insuring the debts of Europe's weaker members also rose on Monday. The Italian five-year credit default swap rose by 32 basis points to 281bp, which means it would cost €281,000 a year to insure €10m of Italian debt.

According to the Financial Times, EU leaders are now preparing for Greece to default on some of its debts – abandoning hopes that private creditors might roll over their borrowings. Gavan Nolan, director of credit research at Markit, said this had driven up the cost of insuring Greek, Portuguese, Spanish and Irish government bonds.