By Ambrose Evans-Pritchard

LONDON, England - December 15, 2010 - Europe's debt woes have moved closer to the core of monetary union after Standard & Poor's threatened to downgrade Belgium over the failure of Flemings and Walloons to form a government.

The warning comes a day after the International Monetary Fund said Belgium "urgently needed" to control spending as public debt pushes above 100% of GDP. "A clear plan is needed to contain contagion from abroad," it said.

The yield spread on Belgian 10-year bonds has ballooned to 102 basis points over German Bunds, raising fears of a funding squeeze next year. S&P said the country needs to refinance debt equal to 11% of GDP next year, leaving it "exposed to rising real interest rates".

"It's ugly for our reputation," said Jean Deboutte, head of Belgium's debt office. "This is bearable but the premiums are mounting little by little."

The country has been limping along with caretaker ministers since Flemish separatists emerged as the biggest party in June. Talks have broken down over the scale of subsidies to the poorer French-speaking areas, making Belgium a microcosm of EMU's North-South divide.

It is unclear whether the political system can muster the discipline of the early 1990s when Belgium came back from the brink of a debt compound spiral with an impressive fiscal squeeze.