Fears over Italy’s political upheaval spread to Wall Street after Europe’s financial markets closed lower.
The prospect of fresh elections and the possibility of eurosceptic parties strengthening their position has raised concern about the eurozone’s stability.
The Dow Jones index shed 1.6% and the S&P 500 lost 1.2%, coming after Italy’s FTSE MIB closed down 2.7% and Europe’s other main markets shed well over 1%.
A sell-off in Italian bonds saw the yield on two-year debt breach 2%.
It meant that short-term Italian bonds suffered their biggest one-day jump in 26 years.
Movements in bond prices are important as they affect the cost of borrowing for the government. Italy’s debt currently stands at 130% of its economic output.
The bond sell-off hit the share prices of European banks exposed to government debt, especially those in Italy. Banco BPM, Banco Generali, Unicredit and BPER Banca closed down between 5% and 6.7%.
On Wall Street, JP Morgan was down 3.7%, and Bank of America and Citigroup were just more than 3% lower. Morgan Stanley fell 5.3%.
Falling bank shares dragged down Europe’s main share markets. At the close the UK’s FTSE 100 fell almost 1.3%, while Germany’s Dax was down 1.5% and France’s Cac 1.3% lower.
“It’s a market that is totally in panic”, said Giuseppe Sersale, a fund manager at Anthilia Capital Partners, who noted “a total lack of confidence in the outlook for Italian public finances”.
Mohamed El-Erian, chief economic adviser at Allianz in the US, said: “If the political situation in Italy worsens, the longer-term spillovers would be felt in the US via a stronger dollar and lower European growth.”
The turmoil was precipitated after the anti-establishment Five Star and League political parties abandoned their attempts to form a ruling coalition after a standoff with President Sergio Mattarella.
He had vetoed their choice of a eurosceptic economy minister, and appointed former International Monetary Fund official Carlo Cottarelli as interim prime minister with the task of trying to form a government.
But his term is likely to be cut short, as he will almost certainly lose a parliamentary vote of confidence. If he does, then new elections would soon follow.