Markets in Turmoil Over Italy Deadlock

World markets turned volatile on Monday, with fears of a hung parliament in Italy rippling across the globe as the outcome of its general election remained highly uncertain.

Investors fear Italy may face a hung parliament with little prospect of technocrat Prime Minister Mario Monti's reform agenda being enacted. Forecasts from Monday afternoon suggested a center-left coalition would win in the lower house, while a rival center-right coalition led by the controversial former Prime Minister Silvio Berlusconi would win the Senate.

European shares rose sharply earlier this afternoon, with Italy's FTSE MIB up 3.8 percent, after exit polls indicated a victory for Pier Luigi Bersani's pro-reform and pro-Europe, center-left coalition.

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However, both European shares and the euro pared gains shortly afterwards, when early vote counts from television channels, including Italian state broadcaster RAI, pointed to a victory for media tycoon Silvio Berlusconi's center-right coalition in Italy's upper house.

U.S. shares also turned negative, with the Dow reversing gains after hitting a fresh multi-year high. The S&P 500 and the Nasdaq also dipped into negative territory.

RAI reported that Berlusconi's bloc led with 31.6 percent in the Senate, with the center-left in second place with 29.4 percent. Beppe Grillo's protest 5 Star Movement came in at 24.9 percent, with international investors' favorite, Monti, trailing at 9.2 percent.

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Markets' greatest fear, said Alessandro Capuano, head of the Italian desk at derivatives trading group IG, is a return to the polls in one year's time.

"The market is looking for a stable government. Here, the risk is that we do not get a government capable of staying for more than one year. That would be the worst scenario we could see from the market point of view," Capuano told CNBC on Monday.

"It is very difficult to get a strong majority in Italy, and stay for the entire legislation, which is four years."

Alberto Saravalle, professor of European and International Law at University of Padua and the parliamentary candidate for the independent 'Stop the Deline' party, concurred.

"I think what the markets are saying is that they want something that will not fall in six months," Saravalle told CNBC on Monday.

Even if Monti and Bersani secure enough seats in both the lower and upper houses to form a working majority - as forecast prior to the election - they will still need a "substantial" number of seats to force through policy changes, said Alberto Gallo, head of European macro credit research at RBS.

"The opposition will be very strong… Grillo says he will not ally with anyone else, and Berlusconi promises to do the same. If in the Senate, the majority only wins by 5-10 percent, then we could see an unstable situation," Gallo told CNBC on Monday.

Gallo said a Monti-Bersani coalition would need to gain at least 160 out of the 220 seats available in the senate to be viable.

Italy's poll stations closed at 2 p.m. London time on Monday, having opened on Sunday. Official voting patterns should be released at 9 p.m. this evening, giving a clearer indication as to whether any party has achieved a clear victory.

The pan-European FTSEurofirst 300 index provisionally closed up 0.1 percent at 1,166.73 points on Monday, off a high of 1,174.24 points. Italy's benchmark FTSE MIB equity index unofficially closed up 0.7 percent.

- By CNBC's Katy Barnato