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Italian 2-year bond yields double in 1 day as election fears roil Europe

Fears of fresh elections, possibly sparking a Greek-style confrontation with the eurozone, sent Italian government debt into a tailspin, with stock markets falling across Europe led by plummeting banks.

The yield on two-year Italian bonds more than doubled, jumping 162 basis points to 2.327% by 8:19 a.m. ET, while the spread between the rate on the country's 10-year bonds and those of Germany shot up by 43 basis points. The euro slid 0.5% to $1.1563, and the Euro Stoxx 50 Index of European banks fell 1.64%. The Euro Stoxx Banks Index slid 4.5%.

The decision by President Sergio Mattarella to veto the appointment of a euroskeptic finance minister backed by the populist Five Star Movement and the Far Right League sent political tensions soaring in Italy and looked set to lead to fresh elections in September. Mattarella's choice of prime minister, former IMF official Carlo Cottarelli, was seen as unlikely to survive a vote of confidence in parliament, but the confrontation showed signs of hardening the anti-EU resolve of League leader Matteo Salvini, who said Italy was "occupied financially by Germans, French and eurocrats."

The League has soared in polls since the March elections, with its support in a recent SWG poll reaching 27.5%, 2 percentage points behind Five Star, which was in first place.

"As in Greece, the next Italian government is unlikely to actually leave the eurozone and lower pensions by redenominating them in a new, less valuable currency," analysts at PNC said in a research note. "But a confrontation with the EU could lead to capital controls on Italy and a renewal of European financial turbulence, especially since Italy is much larger and more important to the eurozone than Greece."

Italy is the eurozone's largest sovereign borrower. Proposals, favored by the League, to issue claims on future tax revenues that would be accepted as payment by the Italian government would also in effect create "a parallel currency to the euro," PNC said.

While investors' fears centered on Italy, other southern European bonds also sold off. Portugal's 10-year bond yield spiked as high as 2.521%, before easing to 2.197%, up 13 basis points. Spain's 10-year bond rose 10 basis points to 1.624%, down from highs near 1.718%.

"Chances are that the perceived institutional wound might induce both the Northern League and the [Five Star] to radicalize their electoral message, but different political outcomes remain possible," ING analysts said in a research note.