Italian banking sector falls 7%, with stock markets down owing to fears stalemate in Rome could lead to eurozone crisis reigniting
Italian banks have borne the brunt of fears that deadlock in Rome following inconclusive parliamentary elections would undermine the country's prospects for recovery.
The banking sector fell 7% in value on Tuesday, dragging the main Italian stock market index 4% lower.
In a sign that investors are wary of the eurozone crisis reigniting, markets in Germany, France and the UK followed suit, with banks among the biggest fallers. Barclays share fell by 4% to 299p while Royal Bank of Scotland, which is still 83%-owned by the UK government, lost 3.4% to close at 342p.
The FTSE 100 was 1.4% lower at 6268 points, the German Dax more than 2% at 7596 and the Paris Cac 2.75% at 3619.
Analysts warned that several smaller Italian banks were vulnerable to collapse if the economic situation worsened.
Rome has pumped €4bn (£3.44bn) into the Tuscan bank Monti Paschi di Siena in recent months after the latter revealed undisclosed losses. Analysts fear more regional banks could go bankrupt without further government support.
To prevent a run on two regional banks, the Italian banking regulator banned financial bets on a decline in their share price, known as short selling. The two-day ban is expected to shore up support for the banks and keep hedge funds that make money from short selling at bay.
Italian bond yields also jumped, indicating that the government will be forced to pay a higher interest rate on its debts.
With debt in excess of 120% of GDP, Italy is vulnerable to a rise in interest rates. Last year, the yields on its 10-year bonds shot above 6.6%. The shock, when combined with Spain's near bankruptcy, forced the European Central Bank governor, Mario Draghi, to issue an emergency statement that the bank would do "all in its power" to protect the euro.
The 10-year Italian bond yield edged back into dangerous territory on Tuesday, moving above 4.9%.
But in a swift indication of the speed that market confidence can evaporate, the government's borrowing costs shot up by more than two thirds at an auction of six-month bonds. Investors demanded a yield of 1.237%, the highest since October. The yield was 0.730% in a similar sale a month ago.
Raj Badiani, an economist at the French bank Société Générale, said pressure was mounting on Italy to its tackle deep-seated employment restrictions and barriers to new private sector investment, adding that without reforms, the country is unlikely to end its double-dip recession, which has last nearly two years.
"Pressure could take the form of rising borrowing costs to painfully high levels, which could force Italy to approach the European stability mechanism (ESM)," said Badiani, referring to the rescue fund already propping up Portugal, Ireland and Greece. But Italy is unlikely to go cap in hand to Brussels, he added.
Public spending cuts pushed through the Italian parliament by Mario Monti's technocratic administration have dramatically reduced Italy's annual budget deficit and restricted the amount of new debt the country needs to sell on the private markets to survive.
Most of the large Italian banks are also protected from a spike in interest rates on their own debt, after raising billions of euros in reserves, much of it in the form of cheap loans from the ECB.
Jeroen Dijsselbloem, the Dutch foreign politician who chairs the eurozone's Eurogroup of finance ministers, said: "I think and I hope there is a broad understanding that there is also a responsibility for the stability of the eurozone as a whole, and that agreements have to be met.
"Pulling Europe from the economic doldrums requires a stable, political policy, also in Italy."
Dario Perkins, an economist at Lombard Street Research, said: "There is a subtle message from these elections. One that if the rest of Europe ignores, will be disastrous for the euro in the longer term. This was a vote against austerity.
"The future of the euro remains in question and if the politicians don't take action to restore growth to the euro area, [Italian comedian and Five Star Movement con-founder] Beppe Grillo might mark the start of a new trend in European politics."
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