Euro zone shares sank to three month lows on Tuesday after an Italian election stalemate renewed concerns about the future of the euro zone and sent investors in search of insurance against a deeper sell-off.
No group managed to secure a majority in the Italian parliament, heralding weeks of political uncertainty and raising the prospect of a government between sworn enemies - the center-right led by former prime minister Silvio Berlusconi and the center-left under Pier Luigi Bersani.
"It was the worst possible outcome, feared by market participants and European policy-makers alike," Tobias Blattner, European economist at Daiwa Capital Markets, said on Tuesday.
"Italy is facing Greek-style political gridlock and possibly new elections."
Italy's benchmark FTSE MIB index sank 4.9 percent, posting its biggest daily fall in nearly a year.
The EuroSTOXX 50 index provisionally closed down 3.1 percent at 2,570.62 points, its lowest finish since Nov. 28. The move extends the euro zone blue chip index's retreat from an 18-month high of 2,754.80 points hit at the end of January.
The pan-European FTSEurofirst 300 unofficially closed 1.3 percent lower at 1,150.58 points.
"It introduces a whole range of uncertainty at a time when the markets were quite toppy anyway and were probably ready for some sort of correction," said Paul Jackson, strategist at Societe Generale.
Pier Luigi Bersani's center-left coalition gained a slim majority in the lower house, winning by 125,000 votes. But no party won a majority in the country's upper house, the Senate, where 158 seats are needed to govern alone.
With no majority in the Senate it will be harder to pass key legislation on economic reforms.
The center-left coalition led by Bersani took 119 of the Senate's seats while Berlusconi's center-right took 117 seats, according to Reuters. Comedian Beppe Grillo's protest party, the "5 Star Movement", will be the largest single party in the lower house, having gained a quarter of the vote.
The two options left open to Italy's politicians are either to form a grand coalition between Bersani, technocrat Mario Monti's centrists and Berlusconi's center-right, or the implementation of another technocrat government. The euro has fallen to almost a seven-week low against the dollar on the news.
But Berlusconi ruled out a coalition with Monti in a television interview on Monday.
If the parties cannot form a coalition, new elections could be held within the year.
Italy's Prime Minister Mario Monti met with Bank of Italy Governor Ignazio Visco, Economy Minister Victorio Grilli and European Affairs Minister Enzo Moavero around midday to discuss the crisis, Reuters reported.
Spanish stocks and bonds were affected by Italy's crisis, as Spain is seen as vulnerable to contagion effects from Italy. However, Nicholas Spiro, managing director at Spiro Sovereign Strategy, said contagion from Italy was still "relatively contained".
Investors also watched as U.S. Federal Reserve Chairman Ben Bernanke testified before Congress on Tuesday. Bernanke strongly defended the U.S. central bank's bond-buying stimulus, saying he sees little risk of higher inflation in the near term.
