Italian two-year bonds nose-dived this week amid a ballooning political crisis now headed for early elections, frightening investors across Europe over a renewed risk of the eurozone breaking up.
Italy's two-year debt yields soared above 2 percent to levels not seen since 2013, while the rate on 10-year notes surged to 2.91 percent, the highest point in four years.
Italy's main stock index extended early losses to sink to a 10-month low, down 3 percent, by 08:40 GMT. Bank shares slumped another 4.8 percent to a fresh 13-month low, bruised by a sell-off in Italian government bonds, a core part of the banks' portfolios.
The index was set for its worst daily loss in 21 months as trade in some banks was halted due to excessive losses.
Worries also sent the euro sliding to U.S.$1.16 at the end of the day Monday from its peak of U.S.$1.17, a 0.1 percent loss.
The head of Italy's central bank said any move to weaken the country's public finances could undermine confidence and years of valuable reforms.
Italy's president set the country on a path to fresh elections on Monday, appointing a former International Monetary Fund official as the interim prime minister with the task of planning for snap polls and passing the next budget.
After inconclusive elections in March, two anti-establishment parties dropped a coalition plan over the weekend after the president vetoed their choice of a eurosceptic to become economy minister.
Investors feared a polarizing election campaign which could deliver a deeply eurosceptic government, threatening the bloc's cohesion. "Italian political risk is delayed rather than resolved," said UBS's chief investment office.
"One has to be concerned about forced selling flow in reaction to the price action," strategist Antoine Bouvet of Mizuho International Plc was quoted as saying by Bloomberg. "It is in Five Star's and the League's interest to benefit fully from [President Sergio] Mattarella's opposition by keeping a united front so there should be limited solace to be found in the near term from news flow."
Intesa Sanpaolo, BPER Banca, Unicredit and UBI Banca fell sharply, down 4.4 to 5.8 percent, while Poste Italiane also tumbled 5.7 percent.
"Banks with lower sovereign exposure, lower NPL (non-performing loan) stock and higher profitability seem more defensive in this environment (like Intesa Sanpaolo, Mediobanca, Fineco) versus the midcap banks (which are more vulnerable given higher sovereign exposure, higher NPLs stock and lower profitability)," said Citi analysts.
Intesa, Unicredit, Banco BPM, UBI Banca, BPER Banca and Mediobanca together have a total of 166.6 billion euros ($192 billion) exposure to Italian sovereign debt, according to Citi calculations.
Italy's economic melt-down sent tremors across Europe, causing Sentix's eurozone breakup index to climb to its highest since April 2017, when investors feared a eurosceptic Le Pen presidency in France.
The pan-European STOXX 600 fell 1.6 percent, with banks the worst-performing. The eurozone's banks index sank 4.3 percent and was on track for its biggest monthly drop since the Brexit vote in June 2016.
The stress in Italy spread to other peripheral eurozone markets, with Spanish and Portuguese bank stocks firmly in the firing line. Portuguese 10-year bond yields jumped as much as 32 basis points to 2.40 percent and Spanish yields rose five points to 1.58 percent.
Banco Comercial Portugues fell 6.7 percent, while Spain's Santander and Sabadell led the IBEX down with 5.9 and 6 percent drops. Spanish stocks slid 2.9 percent while Portugal fell 2.7 percent.
JP Morgan analysts repeated their earlier call for investors to move out of Italian equities and into Germany. German Bunds have been acting as a safe haven for investors, with yields on the eurozone benchmark bond falling, but Germany's DAX was still shedding 1.8 percent as investors fled risky assets.