Italian shares fell sharply today as Prime Minister Mario Draghi resigned, keeping broader European stocks under pressure as investors awaited the European Central Bank's first interest rate hike in more than a decade.
Draghi handed in his resignation to President Sergio Mattarella, plunging the country into political turmoil after three coalition parties withdrew their support for his government at Wednesday's vote.
An early election in September or October will be the most likely outcome. Italy's benchmark FTSE MIB index dropped 2.5%, extending its year-to-date fall to 24%.
The Italian banks index, most sensitive to the political crisis, sank 6.7%, with Intesa Sanpaolo and UniCredit sliding more than 7% each.
"The positive is that this crisis is starting at the level where investors are very cautious already," said Arnaud Girod, head of economics & cross-asset strategy at Kepler Cheuvreux.
"The Italian spread itself is very high and the banks share price is also very depressed. It's definitely important that the ECB delivers on its anti-fragmentation tool, otherwise Italian banks will definitely get weaker than where they are now."
Italian bonds also sold off sharply following the collapse of the Draghi government.
Benchmark 10-year Italian bonds yields soared more than 20 basis points (bps) to their highest since June 28th.
"It is a big blow to Italy's ability to deliver policies and reforms over the near term," said Lorenzo Codogno, head of LCMacro Advisers.
"There will be delays and disruptions with early elections, and most likely no budget by year-end."
The broader pan-European STOXX 600 index was down 0.4%, with all eyes now on the ECB meeting at 1215 GMT.
Investors are waiting to see if the bank delivers a larger-than-signalled 50-basis-point interest rate hike as inflation hit record highs.
A firm ECB commitment on an anti-fragmentation tool is also eyed, especially as the political crisis in Italy saw spreads between Italian and German 10-year bonds widen further.
"The simple fact that this (anti-fragmentation) plan exists or is even on the table, should provide some security and is critical all the more after last night," Girod said.
"If the political situation gets clarified... then we have some clarity that the ECB will likely act to defend the Italian debt."
These worries outweighed some relief over an energy supply crunch as Russian gas resumed flowing through Nord Stream 1, the biggest pipeline between Russia and Germany, at the 40% capacity that was flowing before it shut down for a scheduled 10-day maintenance.
As oil prices fell on demand concerns, crude producers were among the biggest drags on the STOXX 600.
