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Why Italy Could Be the Next 'Bad Boy of Europe'

Michele Falzone | Photographer's Choice RF | Getty Images

Italy could see its borrowing costs rise above those of troubled Spain this week, analysts told CNBC on Monday, with a credit rating downgrade on Friday and continued political deadlock posing an ever larger threat.

"Italy is really going to blow it up this week," Joe Rundle, head of trading at ETX Capitol, told CNBC. "There is the downgrade that happened on Friday but now there is the Italian yield and the spread narrowing to the Spanish yield and there is the possibility that Italy gets more expensive than Spain. The last time we saw that we were in the middle of a euro zone crisis," Rundle told CNBC Europe's "Squawk Box".

Rundle added that while political uncertainty lived on in Italy, there was the potential for Italy to "come unwinding very quickly."

On Sunday, Beppe Grillo's anti-establishment 5-Star Movement reiterated that it wanted to lead Italy's next government rather than form an alliance with any other party.

Grillo's comments followed a credit rating downgrade of Italy by Fitch on Friday. The country was downgraded to BBB plus with a negative outlook. The downgrade was attributed to inconclusive election results in February that have led to a power vacuum and delays to structural reform as no one party gained a majority to form a government.

(Read More: Nouriel Roubini: Italy a 'Tsunami' Risk)

As markets opened on Monday, the FTSE MIB was down 0.5 percent. "We could see these gains we've seen in the last few weeks come off very aggressively," Rundle said. "I think the Italian yield is likely to blow up while the Spanish yield falls and Italy becomes the bad boy of Europe more so than Spain now, so that is where I think the risk is this week," he added.


Italian 10-year bond yields rose 7 basis points on Monday morning to 4.65 percent. Spanish ten-year bond yields fell 3 basis points to trade at 4.73 percent.

"Credit markets continue to underestimate the risk of political instability in Italy and in the periphery, and the calls for a switch from a pro-austerity fiscal compact to a growth compact," research analysts at RBS said in a note on Monday.

"We think these risks will emerge more strongly as the possibility of new elections in Italy becomes reality – which is no earlier than May 15. In the meantime, credit spreads will likely continue to tighten after February's indigestion, as both technicals and growth data remain supportive of the asset class," the analysts continued.

Analysts at Bank of Tokyo Mitsubishi played down the impact of the Fitch downgrade, however.

"The Fitch ratings is still three levels above junk and one above Spain. The one to watch from here is Moody's which has Italy rated at Baa2 leaving just one further level before junk status. S&P has Italy rate at BBB . The Italian 10-year yield over Germany has widened by about 10bps this morning and the reality is that the financial markets reassess sovereign risks on a daily basis and hence, the decision of Fitch is unlikely to have a notable impact on yields or the euro," the bank said in a note to clients.

The Italian Minister of Economy and Finance, Vittorio Grilli, told CNBC that he was confident that a solution could be found for Italy's political stalemate, though he conceded that structural reforms were needed soon.

"I am confident that Italy will be able to provide a solution... I think that will be a positive outcome that will be judged by the markets," he told CNBC at the Ambrosetti forum in Italy.

"Of course, [the] international community and markets like certainties not uncertainties, so the faster we are able as a country to provide certainly and so clarification about the political and administrative future of Italy the better it is," Grilli told CNBC on Saturday after the downgrade.

(Read More: Italy Elections Could Derail Economy Further)

Grilli denied that the country, which Fitch predicted would see its debt peak at 130 percent of gross domestic product (GDP), would need to resort to financial aid from Europe in the form of the European Central Bank's bond-buying program, calledOutright Monetary Transactions (OMT).

"Well our position and my position, the [Monti] government's position has been that Italy doesn't need an OMT program, we don't need the funding… It's not a question of funding, it's a question of pursuing a structural reform program that we have started. A large and important country such as Italy has to find the strength within itself to pursue those reforms," he added.

Contact Europe: Economy

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