Mounting fears about political instability in Italy and Spain sent tremors through the eurozone’s two largest peripheral debt markets on Friday with investors dumping the sovereign bonds of both countries and sending European bank shares sharply lower. A two-week sell-off of Italian debt accelerated after the two populist parties poised to govern in Rome failed yet again to get presidential approval for a slate of ministers, with leaders divided over whether to appoint an arch-Eurosceptic as finance minister. The long-running Italian drama was unexpectedly joined by the prospect of a government collapse in Spain after the main opposition party called for vote of no-confidence in the minority rule of prime minister Mariano Rajoy, whose centre-right Popular party has been racked by a campaign finance scandal. Although the decision by Socialist leader Pedro Sánchez to table the confidence vote sent the main Spanish stock index down as much as 2.7 per cent and the country’s benchmark government bond yield had its largest one day move since September, most of the political and market focus remained on Italy. “We saw in Greece how dangerous it is if a country has a bigger and bigger debt and I hope that we will not have a second Greece in our neighbouring country, Italy,” Sebastian Kurz, the Austrian chancellor, told the Financial Times. The Italian sell-off left two-year bonds yielding nearly 130 basis points more than Germany’s equivalent debt, a spread that saw its biggest one-day widening since the tail-end of the eurozone crisis in late 2013. Luigi Di Maio, the head of Italy’s largest political party, the anti-establishment Five Star Movement, and his coalition partner, far-right League leader Matteo Salvini, have backed Paolo Savona, an 81-year old Eurosceptic economist, as finance minister. But resistance from Sergio Mattarella, the Italian president, who is said to be worried Mr Savona could damage Italy’s credibility in the EU and the markets, has held up the formation of the government all week. Political novice Giuseppe Conte, tapped as prime minister on Monday, was expected to propose his cabinet on Friday and have it sworn in at the weekend, but he held an “informal” meeting with Mr Mattarella instead and did not present a list of ministers. At the end of a tense day, Mr Salvini posted a cryptic message on social media. “I am truly angry,” he wrote. The post was “liked” by Mr Di Maio. Moody’s then delivered another blow to the budding government, placing Italy’s Baa2 credit rating on review for a downgrade. The rating agency cited the “significant risk of a material weakening” in Italy’s fiscal strength and the “risk that the structural reform effort stalls [and] that past reforms …are reversed”. Spain remains in a far less precarious fiscal situation than Italy despite having gone through an EU-funded bank rescue in 2012, having sharply cut its budget deficit and chipped away at its national debt in recent years. But its bout of political instability, which could precipitate snap elections, comes at a difficult time, with investor sentiment beginning to turn against the eurozone. “It’s easy to see how vulnerable heavily indebted countries can become if investor confidence is eroded,” said Mark Dowding, co-head of developed markets at investment group BlueBay Asset Management. Mr Sánchez’s gambit was triggered by a damning court ruling that handed down fines and prison sentences to politicians and businesspeople connected to Mr Rajoy’s party on Thursday. The liberal Ciudadanos party, which backs Mr Rajoy’s minority government, said it would not support Mr Sánchez but might back a similar motion unless Mr Rajoy called early elections. Luca Cazzulani, deputy head of fixed income strategy at UniCredit said of the rise in Italian short-term borrowing costs: “While there have been a few other such episodes since the start of quantitative easing, this is the strongest one …Given the very high uncertainty on Italy, investors are likely to remain cautious for now.” The upward moves are likely to feed through into the cost of servicing Italy’s debt; the country is expected to sell up to €1.75bn of two-year paper on Monday in an auction which Mr Cazzulani said would be “closely watched”. Shares in Italian banks and other financial stocks also fell sharply. Banco BPM tumbled 7.5 per cent, while lender Intesa Sanpaolo fell by 4 per cent. UniCredit, UBI Banca and Mediobanca all lost around 3.5 per cent. The sense of risk aversion was highlighted by the strong rally in German debt, seen as a haven across Europe. The 10-year Bund yield fell as low as 0.387 per cent, a level not seen since late 2017, from 0.468 per cent on Thursday. US Treasuries, another perceived haven, have seen similar buying. Bond yields move inversely to prices.

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