Italy is headed for a temporary government and early elections as markets greeted the collapse of a potential coalition between two populist parties with strong eurosceptic leanings.
Italian President Sergio Mattarella is expected to ask former International Monetary Fund official Carlo Cottarelli to form a temporary government, according to Reuters.
The euro also rebounded after hitting a six-month low at the end of last week, although it gave up some of the early gains as trading continued to trade at $1.166 against the US dollar, having earlier in the day reached $1.1728.
The populist Five Star Movement and the right-wing Northern League had agreed to form a government based on their common anti-establishment stance, in spite of major political differences.
However, the Prime Minister designate, Giuseppe Conte, yesterday said he had "returned the mandate" to form a government offered by Mattarella after the President vetoed the appointment of a veteran eurosceptic as economy minister.
Matarella said he could not allow an economy minister who wants Italy to leave the Eurozone, reassuring investors who fear the exit of one of the single currency's most important members.
The yield on the Italian 10-year government bond fell back to below 2.35 per cent in early trading as investors greeted the collapse of the potential coalition, before rising to around 2.44 per cent at the time of writing, according to Tradeweb.
The spread between Italian and German 10-year yields – a measure of the premium investors demand which is highly sensitive to political risks – fell back below 200 basis points, after widening dramatically in the past month to hit heights last seen in April last year.
The moves come after a month in which the price of Italian government bonds, which move inversely to yields, has fallen dramatically following fears a high-spending and eurosceptic government could endanger the Italian economy and the Eurozone.
The President's refusal to ratify the coalition cabinet could put Italy on track for yet another election, continuing the political deadlock in the country. However, markets have in the past welcomed technocratic governments in Italy.