Prospects that Italy's elections will result in an American-style gridlock hammered stocks nearly 5 percent and government bonds on Tuesday.
Pier Luigi Bersani's center-left coalition, the pre-election favorite, won by the thinnest of margins and may form an alliance with outgoing Prime Minister Mario Monti’s party. A late surge by former Prime Minister Silvio Berlusconi's People of Freedom center-right coalition, and a surprising showing by comedian Beppe Grillo protest-minded Five Star Movement, eroded the center-left's advantage in the polls, which had been as high as 10 percentage points in late 2012.
The upshot spelled policy paralysis for the markets; Stocks in Italy, Europe's third-largest economy behind Germany and France, Italian stocks plunged Tuesday by 4.6 percent and the spread between Italian government bond yields and the benchmark German government bonds grew to a level not seen in two-and-a-half months, Reuters said.
"Italy looks set for a potentially long period of political uncertainty, which is likely to prompt government bond yields to continue to climb higher," Capital Economics said in a note.
"Of course, the possibility of bond purchases by the European Central Bank might stop yields rising back to or above the supposedly critical 7 percent threshold. Nonetheless, given the particularly bleak economic backdrop for Italy and the growing risk that the next Government will at best have a limited mandate to continue the reform process begun by Mario Monti, we would not be surprised if a sustained bout of market pressure were to force Italy to eventually to request some form of support package."
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