The yield on Italian government 10-year bonds rose to a seven-week high Thursday, while stocks sold off, following news that former Prime Minister Silvio Berlusconi will not stand in the way of a new coalition government.
The anti-establishment Five Star (M5S) and right-wing Lega parties are said to be closing in on an agreement to form a ruling coalition for the euro zone's third largest economy.
Benchmark 10-year Italian yields jumped to 1.94 percent in early trading and the spread between Italian debt and its German counterpart stretched to its widest in six weeks. The FTSE MIB equity index in Milan is more than 1 percent lower.
Charlie Diebel, head of rates at Aviva investors, told CNBC on Thursday that If M5S and Lega were to form a government, markets would be "a little cautious" as to what they might do.
He added that investors are wary that both might fulfil pre-election commitments to trim fiscal austerity or attempt to renegotiate reform pledges with the European Union (EU).
Berlusconi's presence as an ally to Lega had previously been a sticking point for M5S, preventing the two parties from brokering a political deal.
But Diebel said the former leader's self-enforced absence should not be read as an end to his political career and could even prove astute should M5S and Lega fail to gel.
Italian President Sergio Mattarella has given both parties 24 hours to reach a deal before he appoints a caretaker cabinet.
Italy has been without a government since an inconclusive vote on March 4 that saw M5S gain the most votes.
The election also saw big gains for the center-right alliance led by Lega. The center-left Democratic Party (PD) suffered heavy losses to come third.