Italian Prime Minister Mario Monti's pledge to step down after a fallout with his predecessor Silvio Berlusconi, who plans to make a political comeback, drew on Monday negative market reactions and concern from European partners.
Monti on Saturday said he would resign after parliament approves a budget law by the end of this month. His decision, which opens the way for early elections in February or March, came after Berlusconi's party withdrew its support for his government last week.
"If I had to express my feelings today sincerely, I would say that I am very worried," Monti told the centre-left daily La Repubblica. He said he announced his resignation on the weekend so that markets could digest "the eventual blow, hoping of course there will not be one."
The Milan stock exchange was down 3.4 per cent by around 2pm (1300 GMT), with bank shares suffering the most. The yield differential between Italian 10-year bonds and equivalent German bonds was hovering around 3.6 percentage points, up from 3.3 on Friday.
The so-called spread - the benchmark risk indicator on Italian public debt - had started rising last week following the announcement of Berlusconi's return as leader of Italy's conservatives, a development that laid the ground for Monti's resignation.
Bond auctions on Wednesday and Thursday were expected to further test investors' feelings about Italy.
Monti has adopted tough austerity measures and passed unpopular labour and pension reforms. The concern is that Berlusconi will wage a populist campaign against those measures, which have helped restore Italy's international credibility.
Germany, the most influential member of the European Union, called for Monti's work not to be undone.
"We expect that Italy will continue to fully comply with its agreed European obligations and continue on the reform path it has started," a spokeswoman for Finance Minister Wolfgang Schaeuble said in Berlin.
Speaking before meeting EU counterparts in Brussels, Foreign Minister Guido Westerwelle added: "Italy cannot break off now the started reform path. Italy has two-thirds of the reform road behind it, but the last third is crucial."
Italy is the third-largest eurozone economy, and the bloc's rescue funds are thought to be too small to bail it out in case it could no longer borrow from the markets. Westerwelle said an Italian crisis could land the whole of Europe "in a maelstrom."
In Spain, Economy Minister Luis de Guindos expressed concern about knock-on effects on his country. The spread on Spanish 10-year bonds rose to around 4.3 percentage points on Monday, from under 4.2 on Friday.
"There is no alternative for sound public finances. There is no real alternative for what Mr Monti is doing," EU President Herman Van Rompuy warned from Oslo, where he was attending the Nobel Peace Prize ceremony.
Analysts are expecting market anxiety to continue, at least in the short term. But they also said confidence could return if Monti were to break out of his non-partisan role and take a stand in the upcoming elections.
"Italy should be very careful not to erode the credibility capital accumulated by Monti's government so far," Britain's Barclays Capital said in a note to clients Monday.
"Monti's commitment to assuming a central role in Italian politics would be the best way to preserve it in the eyes of European partners and financial markets," it added.
Asked by La Repubblica about that possibility, Monti said: "I don't know, I really don't know."
Berlusconi stepped down in November 2011 at the height of a financial crisis that had sent the German-Italian bond yield spread close to 6 percentage points, a level which, if sustained, would have pushed the country to bankruptcy.
The French leftist daily Liberation on Monday published a photo of
the scandal-plagued 76-year-old who served three terms as Italian premier under the headline "Return of the mummy".
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