Markets have been shaken by political turmoil in Italy, where the formation of an interim government has been delayed. Nicole Winfield looks at the background.

What is happening in Italy?

THE failure of new prime minister-designate Carlo Cottarelli to form a cabinet has sparked political upheaval that is likely to lead to new elections.

Investors believe the vote could see Italy moving closer to abandoning the euro if the populist League Party and Five Star Movement gain more ground in any poll.

That could have major implications for the European financial system and its economy. The prospect of a new vote fuelled by anti-establishment and populist outrage sent stock markets plunging along with investor confidence in Europe’s third-largest economy. However on Wednesday, Mr Cottarelli said “new possibilities” have emerged over the forming of a government based on the outcome of the March 4 election. He also wants to give the option time to mature, given the negative market reaction to the prospect of a new poll. His statement added: “This circumstance, also considering market tensions, has compelled him to wait for further developments.”

Officials at President Sergio Mattarella’s office said he agreed with the decision.

How bad was the markets’ reacted?

ITALY’S political turmoil has stoked fears of instability in the eurozone, causing stocks to fall globally and knocking the single currency.

Investors have also dumped Italian government bonds, driving borrowing costs sharply higher for the country and rekindling fears of more financial strain for Europe’s third-largest economy.

Markets in the Far East were also feeling the strain. On Wednesday Japan’s Nikkei 225 stock index dropped 1.5 per cent, South Korea’s Kospi dropped 1.8 per cent and the Hang Seng in Hong Kong slipped 1.2 per cent. Jingyi Pan of investments provider IG said: “Worries over geopolitics look set to hit Asia after sweeping through Europe and also the US at the start of the week.

“That being said, a heavy data calendar from Wednesday could shift some attention back to economic growth and monetary policy.”

Markets in Europe relaxed after yesterday’s news, with the Milan stock exchange maintaining its upward momentum, up 0.8 per cent.

Will there be an impact on Britain’s economy?

BRITAIN is not in the eurozone and UK banks have already reduced their exposure to Italy, so the impact is limited, for now. However, the FTSE 100 has been pummelled, with £25bn wiped off the value of the blue chip index on Tuesday.

Italy abandoning the euro would also be bad for Europe as a whole as it would be likely to trigger a financial crisis in one of the continent’s biggest economies.

The pound would normally benefit from a continental crisis as investors flock to safe haven assets, but since the Brexit vote the pound has fallen out of favour and has moved up only marginally against the euro.

What are the likely political implications for the UK?

ANALYSTS fear that the Euroscepticism of the League Party and Five Star Movement could ultimately spill over into a Brexit-like disaster where Italy not only crashes out of the single currency but also out of the EU.

But that is a long way off and Britain has its own political crisis brewing.

Theresa May’s Conservative Party is yet to ink a Brexit transition deal or give any indication whatsoever of how it plans to honour its pledge to deliver the “exact same” benefits of EU membership from outside the bloc.

What are the experts saying?

SOME believe that a full blown crisis is under way. Others, such as UBS chief economist Paul Donovan, think it is overblown.

“Everyone needs to take a deep breath and calm down,” he said.

“Bond market moves do not break up monetary unions. Bank runs do. There is no evidence of bank runs. Neither Italian parties nor Italian voters support leaving the euro.”