Markets rocked by Italian political stalemate

Stock markets fell sharply across Europe on Tuesday as the deadlock following the Italian general election inflamed the eurozone financial crisis.

The Milan market tumbled by 5%, and there were heavy losses in London, Berlin and Paris. Italian government debt slid in value, pushing up the country's borrowing costs, while the euro hit a seven-week low as Europe's debt crisis once again dominated world markets.

After Monday night's frenzy of exit polls and projections, Italians woke to a scene of electoral stalemate. No party has a majority in the Italian Senate, or upper house, while the centre-left group, led by Pier Luigi Bersani, has won control of the lower house.

Many analysts were also stunned by the success of Beppe Grillo, the comedian-turned-politician, whose Five Star Movement won more votes than any other party.

Five Star is expected to win 54 seats in the Senate, compared with the centre-left's 119, and 117 for the centre-right bloc of Silvio Berlusconi. That appeared to leave Grillo holding the balance of power in the Senate, with some votes still to count.

After conceding defeat in the lower house of parliament, Silvio Berlusconi told a TV station that Italian politicians must reflect on the vote and "make sacrifices" for the good of the country. The former prime minister said he did not favour a second election, indicating he could hammer out a coalition with Bersani.

"I don't think that [a new election] would be helpful in this situation because there are no political programmes that have been discussed. The only one to have put forward programmes in this campaign was me," Berlusconi told Canale 5 television.

Berlusconi also ruled out a deal with Mario Monti, the current technocrat leader who replaced him in November 2011 and who only won around 18 of the 315 Senate seats available.

Bersani's failure to win a majority in the Senate, and Monti's poor performance, disappointed the financial markets. The Italian FTSE MIB had suffered a 4.5% rout by early afternoon in Milan. In the City the FTSE 100 index of leading shares was 85 points lower at 6269, a 1.3% drop that put it on track for one of its worst performances of the year. The German DAX fell 1.65% and the French CAC was 2% down.

The euro fell as low as $1.304 against the US dollar, its weakest point since early January.

With Italy threatening to drag Europe into a new phase of the crisis, Germany's foreign minister Guido Westerwelle said it was vital that a stable government was formed quickly – one that continued with the reform programme begun by Monti.

Economists, though, argue that Italians have dealt a big blow to the policies of austerity and fiscal consolidation demanded by Berlin and Brussels.

"Although Italians remain pro-EU, this election was a major blow for the Brussels cash-for-austerity consensus, and any plans for structural reform in Italy are likely to be put on ice," said Open Europe, the thinktank.

Robert O'Daly, Italy analyst at the Economist Intelligence Unit, said Grillo had shaken "Italy's political establishment to its core", and that Italy is now "looking ungovernable".

"The financial markets are responding as expected. Major global stock markets are all down, with the Italian bourse shedding over 4% of its value at the start of today. The uncertainty will push up government borrowing costs," he predicted.

On Monday night, Grillo told Five Star supporters that their movement would reshape Italian politics. "They've been there for 25 to 30 years and they've led this country to catastrophe," he said. "We will be an extraordinary force."