Italian Prime Minister Mario Monti's imminent resignation drove up the country's borrowing costs on Monday, as markets took fright at the prospect of a return to an old-style Italian political crisis.
The spread between Italian BTPs and German Bunds widened to 349 basis points from 325 late on Friday and BTP future shed more than a point on concern over Monti's departure.
On Saturday, the 69-year-old former European commissioner unexpectedly struck back against Silvio Berlusconi's People of Freedom (PDL) party which withdrew support from his government last week.
After meeting President Giorgio Napolitano on Saturday, Monti announced he would resign as soon as the 2013 budget is passed.
The vote was already scheduled for no later than April and will now likely take place in February, but it may unnerve markets especially since Berlusconi announced his intention to seek a fifth term as prime minister.
Berlusconi was forced to resign last year during a ballooning eurozone debt crisis that had pulled Italy into its vortex while his government put off needed reforms, and amid a sex scandal involving his "bunga bunga" parties.
Opinion polls give the 76-year-old billionaire little chance of success, with the center-left Democratic Party (PD) under Pier Luigi Bersani holding a strong lead. But the campaign could renew uncertainty about Italy's commitment to reform.
A former communist who is close to Italy's unions, Bersani has promised to stick to the promises on fiscal discipline the government has made to European partners and has said that Monti is likely to continue playing a role after the election.
The main barometer of investor confidence, the yield on the 10-year Italian government bond, spike up to 4.74 percent although that is way below the 7.3 percent peak hit last year when the spread with German Bunds hit 550 points.
Analysts said higher Italian bond yields could be short lived, especially if Monti makes clear that he will play a role in ensuring stability, either by returning to government or in a role such as president of the Republic.
"I wouldn't be overly worried because the elections are just one month earlier. A lot will now depend on Bersani's move, whether he can convince Monti to stay on," said one Milan investment banker.
Monti said he was not sure of his political future in comments to Italian daily La Repubblica published on Monday.
"I don't know," he was quoted as saying. "If I had to ... describe my feelings today, I would say that I am very concerned."
"We will see what happens," President Napolitano told reporters on Sunday when asked about how the financial markets would judge the sudden end of Monti's government.
The former European commissioner came to power at the height of the financial crisis a year ago and was widely credited with restoring Italy's credibility with investors and European partners after the scandal-plagued Berlusconi era.
"Monti has been able to do a lot in a short period of time, in particular on the fiscal side. I do not see any serious risk for the country," said Gian Maria Gros Pietro, a former chairman of oil giant Eni and a board member of carmaker Fiat.
Monti has set a target of balancing the budget on a growth adjusted basis in 2013 and says that much remains to be done to revive Italy's stagnant economy, the slowest growing in the eurozone for more than a decade.
But Italians are heavily burdened by the recession, which began mid-way through last year and shows no signs of letting up. Many blame Monti's taxes for making it worse. Unemployment is at a record high and consumer spending has collapsed.
Aware of the economic climate, Berlusconi on Wednesday said Monti had taken Italy to the edge of an "abyss" and that his policies were causing a recessive spiral.
"Beware of Italian anger", the anti-establishment 5-Star Movement leader, comic Beppe Grillo, warned on Sunday in his blog. Grillo also is calling for a referendum on whether to keep the euro.
For now, both Berlusconi's PDL and Grillo's 5-Star Movement are trailing the PD by 10-20 percentage points, especially after a primary picked Pier Luigi Bersani — who promised to continue down the path set by Monti — as the party's candidate last week.
© 2014 Thomson/Reuters. All rights reserved.