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Italy 'Hung, Drawn and Quartered' by Political Deadlock

Tuesday, 26 Feb 2013 | 1:20 AM ET
Greg Christensen | Photographer's Choice | Getty Images

European markets are braced for a sell off on Tuesday as Italy's election results could result in a political deadlock, causing economic chaos and further damage to the euro zone.

Pier Luigi Bersani's center-left coalition won a slim majority in the lower house but no party won enough seats to win a majority in the country's upper house, the Senate.

With deadlock in the Senate it will be harder to pass key legislation needed for economic reforms. The euro has fallen to almost a six-week low against the dollar on the news.

(Read More: Euro Rally: Was It Too Good to Be True?)

The center-left coalition led by Bersani took 121 Senate seats while Berlusconi's center-right took 117 seats, according to Reuters. Comedian Beppe Grillo's protest party, the "5 Star Movement," has become the largest single party in the lower house, having gained a quarter of the vote.

Researchers at Citi said Italy's parliament had been "hung, drawn and quartered" by the election result.

"This result extends political risk in the euro zone," the Citi note said on Tuesday. "The high political uncertainty that is likely to persist in the coming period will likely have a negative impact on real and financial investment decisions in Italy."

Italy's Political Limbo
After an election that left no party with a clear majority, Steve Sedgwick asks what is next for Italy.

The researchers concluded that the over-performance by Grillo and under-performance by Monti were "clear signals" of the anti-austerity message conveyed by voters, which could make further fiscal consolidation efforts "very difficult to implement".

(Read More: Markets in Turmoil Over Italy Deadlock)

Italy's politicians can either form a grand coalition between Bersani, technocrat Mario Monti's centrists and Berlusconi's center-right group or risk another technocratic government if they are to prevent further elections within twelve months, analysts have told CNBC.

Though Bersani and Monti have said all parties must work together, anti-Europe, anti-euro and anti-austerity parties headed by Berlusconi and Grillo have received 50 percent of the public vote, sending a clear signal to politicians that there is no mood for more austerity dictated by Brussels.

If these options are not successful, new elections could be held within the year. Meanwhile, Italy's vital reform program could be stalled or obstructed, potentially damaging the country's economic recovery. There are growing calls for electoral reform in Italy to prevent hung parliaments in the future.

Even the world's biggest bond manager weighed in, with Pimco's Bill Gross tweeting, "Are Italians voting for Austerity, Prosperity, or Promiscuity? The world's markets hang in the balance," he tweeted Monday evening.

The Euro Crisis Has Not Gone Away: Strategist
Jane Foley, senior currency strategist at Rabobank, tells CNBC that market euphoria has been disconnected from the fundamentals and the Italian election is a wakeup call.

Ten-year Italian bond yields have risen 17 basis points to 4.55 percent , since the news of an uncertain outcome spread on Monday but the Italian treasury is going ahead with a sale of 6.5 billion euros ($8.5 billion) of 5 and 10-year bonds on Wednesday.

"The absence of cohesive political leadership may also make euro zone crisis management more complicated," Citi said.

"All this is likely to cause wider and more volatile government bond spreads in the coming weeks/months. Moreover, pressure on Rome is likely to result in some form of external financial assistance, but unsettled politics may significantly delay any agreement in this respect."

Contact Europe: Economy

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