Fears fresh Italian election will be a 'euro referendum'
Chaos ruled the Italian markets yesterday as the nation plunged deeper into political turmoil, with knock-on effects for other highly-indebted eurozone countries - including Ireland.
Italy's borrowing costs for two-year bonds surged to the highest level in four years on Monday - a holiday in much of Europe - while stocks slumped for a fourth day as President Sergio Mattarella asked economist Carlo Cottarelli to form a government.
The former IMF official will be a caretaker leader until new elections, possibly next autumn. However, he said yesterday he'd try to push that out until early 2019.
Earlier, Matteo Salvini - leader of the League, which had been on the verge of forming a coalition with the Five Star Movement - said it made no sense for Italy to remain in the EU unless the bloc rewrote its rules. In response, markets ricocheted yesterday - from early relief that euro-sceptic economist Paolo Savona would not become Italy's finance minister, and fear that the political impasse may plunge the eurozone's third-biggest economy and largest borrower into an even bigger crisis.
Italian assets initially surged early in the day after President Mattarella vetoed the choice of Mr Savona for finance minister.
However, the anti-establishment Five Star Movement said it was considering proposing impeachment of the president, while the League's Matteo Salvini reiterated his support for Mr Savona's candidacy and made a thinly-veiled call for fresh elections.
Analysts at Societe Generale said the outcome of any fresh vote looked "more threatening than ever".
At Berenberg bank, the view is that fresh elections could become a referendum on membership of the single currency - after this year's ballot focused heavily on migration.
Rene Albrecht, a rates and derivatives analyst at DZ Bank AG in Frankfurt, said a fresh election was unlikely to break the current impasse.
"There's a high probability that Five Star and the League could get a majority again, and we would be back at this point where we get a government which wants to spend a lot more than they earn and clashes with EU rules," Mr Albrecht said.
On the markets, the yield on two-year Italian bonds - a guide to how much the country would have to pay to borrow on the market - has doubled since Friday to 0.99pc. Italy's 10-year bond yield climbed to 2.70pc. Italian 10-year bonds are a big driver of the rest of the market. Spanish and Portuguese borrowing costs moved higher in the wake of Italy yesterday. Low-risk borrowers, such as Germany, saw their yields drop thanks to a so-called flight to quality. An analyst at Cantor Fitzgerald in Dublin said Ireland's bonds, along with Belgium's, were treading water between the two camps.
Last Friday, Moody's put Italy's credit rating on review for a possible downgrade, citing risks to its fiscal strength from the government plan put forward by the populists.
President Mattarella became the target of populist rage when he said he rejected their choice for finance minister for "the good of the country" and the financial "savings of families" that had been endangered by rising bond spreads and market concerns. (Additional reporting Bloomberg and Reuters)