Italy's power struggle is rattling global financial markets, with investors fearful the looming prospect of fresh elections could be fought over the country's role in the European Union and the euro zone.
Rome's latest political crisis comes at a time of elevated tensions between euroskeptic populists, who emerged victorious from the March election, and pro-EU establishment lawmakers.
The euro zone's third-largest economy has been without a government since an inconclusive vote in early March, with anti-establishment political groups abandoning their efforts to form a coalition over the weekend amid a dispute with the country's head of state.
President Sergio Mattarella, who was installed by a previous pro-EU government, refused to accept the nomination of euroskeptic candidate Paolo Savona for economy minister on Sunday.
Instead, he set the country on a path to another snap vote by appointing former International Monetary Fund (IMF) official Carlo Cottarelli as interim prime minister. Cottarelli, who became known as "Mr. Scissors" for his reputation regarding cuts to public spending in Italy, is now tasked with the planning of fresh elections and passing the next budget.
The decision to appoint Cottarelli to form a temporary administration prompted the Five Star Movement (M5S) and the right-wing Lega Party (League) to switch back to campaign mode. Both parties had already accused Mattarella of betraying Italy's electorate by blocking Savona's nomination.
"Speaking as an economist, in the past few days tensions on the financial markets have increased… Nonetheless the Italian economy is still growing and the public accounts remain under control," Cottarelli said Monday.
The prospect of another election in Italy as early as September hit European markets Monday, with external observers suggesting the move could delay a future populist government determined to renegotiate key euro zone debt agreements.
The euro tumbled to a fresh six-month low on Tuesday, while yields on Italian debt climbed — ratcheting up the extra borrowing costs or spread that Rome pays in comparison with Germany.
"In new elections, the radicals will likely rail even more loudly than before against Italy's pro-European 'establishment' and an alleged 'German hegemony' exercised through the rulebook of the single currency," Holger Schmieding, chief economist at Berenberg, told CNBC in a research note published Monday.
He warned that Italy's anti-establishment parties had become well-placed to fight a new election campaign on a more explicit anti-euro platform.
"Especially the Lega may frame a new election as a de facto referendum on Italy's role in Europe," he added.
Amid a deepening sense of political and constitutional turmoil in Italy, Luigi Di Maio of the populist M5S said Sunday that the actions of Italy's president had triggered an "institutional crisis."
Di Maio also called for Mattarella to face impeachment charges.
The Italian president, who serves as head of state and is supposed to be politically neutral, took the unprecedented step of blocking Savona's nomination on the grounds that the candidate had previously threatened to pull Italy from the single currency.
In a televised address, Mattarella said Sunday: "The uncertainty over our position has alarmed investors and savers both in Italy and abroad… Membership of the euro is a fundamental choice. If we want to discuss it, then we should do so in a serious fashion."
While he had agreed to all other ministerial picks, Italy's president said he still had the right to block nominations when it concerned matters that could potentially harm the state. He added that both M5S and Lega had refused to put forward any other candidates for the role of economy minister.