Italy's borrowing costs fell sharply today after anti-establishment parties revived a coalition deal, apparently averting snap elections.

However, investors' focus switched to Spain where the prime minister is set to be toppled. 

Pedro Sanchez was almost certain to become Spain's new leader after his Socialist party secured enough votes to force Mariano Rajoy from office in a no-confidence vote today that will throw the political spotlight onto a second southern European state. 

Still, efforts to end three months of political turmoil in Italy were the main focus in early trade, pushing peripheral euro zone bond yields down for a third day in a row. 

Italian two-year yields, which soared to five-year highs above 2.7% on Tuesday in a throwback to the euro debt crisis, retreated back to Monday's levels. 

The leaders of Italy's right-wing League and the 5-Star Movement last night patched up their alliance after agreeing to substitute a eurosceptic they had initially proposed as economy minister and who had been rejected by the head of state. 

The coalition deal promises to increase spending and challenge European Union fiscal rules, policies that could limit any recovery in bond markets.

Italy's prime minister-designate Giuseppe Conte last night announced his ministerial line-up after being handed a mandate for a second time to form a new populist government. 

Far-right League leader Matteo Salvini was named interior minister while the head of Five Star Movement Luigi Di Maio is slated to become minister for economic development.  

Paolo Savona, the eurosceptic economist who the populist coalition originally wanted for economy minister but was rejected by the italian president, is still part of the cabinet as European Affairs minister. 

The role of economy minister this time went to Giovanni Tria, a political economy professor who is in favour of keeping Italy in the euro, while Brussels savvy Enzo Moavero Milanesi was named as minister of foreign affairs.

Italian two-year bond yields fell 46 basis points to 0.71%, retreating back to levels before a market rout on Tuesday that saw yields rocket to five-year highs. 

Ten-year Italian bond yields were 23 bps lower at 2.61%, well below peaks seen earlier this week above 3%.  

The yield gap over benchmark 10-year German bond yields tightened to 224 basis points from 242 bps last night. 

The no-confidence vote in Spain could bring some volatility but was unlikely to deal bond markets a significant blow, analysts said.