Italian political crisis batters European markets with euro dropping to new low

London — A deepening political crisis in Italy provoked a second day of heavy selling on European financial markets, with the euro cut to a six-and-a-half-month low, saw stocks punished and short-term borrowing costs surging for the government in Rome.

Investors fear that repeat elections — which now seem inevitable in the eurozone’s third largest economy — may become a de facto referendum on Italian membership of the currency bloc and the country’s role in the EU.

Short-dated Italian bond yields — one of the most sensitive gauges of political risk — soared as much as 80 basis points to their highest since late 2013 as investors’ anxiety deepened.

The euro dropped below the $1.16 line for the first time insix-and-a-half months, down 0.3% on the day. Against the Swiss franc, it fell by a similar margin at 1.1528 francs.

Stocks in Milan slid 2.6% on the main index after a 2.1% fall on Monday. Bank shares slumped another 5%, having lost 4% in the previous session, bruised by the sell-off in government bonds, a core part of Italian banks’ portfolios.

“It is just a slide and as the slide continues, you ask where the end is ,” said Saxo Bank’s head of FX strategy John Hardy. He added that there was a risk of global contagion, with the benchmark US S&P 500 stocks index also close to breaching some key support levels.

Hardy recalled a promise made in 2012 by European Central Bank (ECB) president Mario Draghi to keep the euro intact. “If this continues for another couple of sessions I think you will have to see some official [European] response. A ’whatever it takes’ kind of moment,” he said.

Adding to the uncertainty, Spanish Prime Minister Mariano Rajoy will face a vote of no confidence in his leadership on Friday.

Spain’s bond-yield spread with Germany was also at its widest in seven months at 122 basis points. Madrid’s IBEX bourse was down almost 2%.

Asia flinched too. Japan’s Nikkei slipped 0.6%. Chinese shares were in the red, too, with the blue-chip index down 0.6% and Hong Kong’s Hang Seng index off 0.7%. E-Mini futures for the S&P500 also gave up early gains to be down 0.5%.

Meanwhile, the dollar was up against almost all major currencies except the safe-haven yen. The dollar is heading for its best month in one-and-a-half years — a move that is hurting many emerging-market countries that borrow in dollars. “This should keep the risk trades pressured to the downside,” Nick Twidale, Sydney-based analyst at Rakuten Securities Australia.

Away from Europe, the focus was also on the on-again, off-again US-North Korean summit and the US-China trade relationship. An aide to North Korean leader Kim Jong-un arrived in Singapore on Monday night, Japanese public broadcaster NHK reported, and the White House said a “pre-advance” team was travelling to the city to meet the North Koreans.

The reports indicate that planning for the summit, initially scheduled for June 12, is moving ahead after President Donald Trump called it off last week. A day later, Trump said he had reconsidered, and officials from both countries were meeting to work out details.

Play it safe

In another sign that investors were flocking to safer bets, the euro hit an 11-month low against the yen and a fresh six-and-a-half-month low against the Swiss franc.

Elsewhere in bonds, US 10-year treasury yields were at six-week lows at 2.883% after a US holiday on Monday. Yields move inversely to price.

Analysts are awaiting US inflation data later in the week, which could provide clues to future interest rate rises ahead of the US Federal Reserve policy meeting next month.

Oil prices remained under pressure from expectations that Saudi Arabia and Russia will pump more crude, even as US oil output rises. US crude futures tumbled to six-week lows and looked set for a fifth straight day of declines. The July contract was last down 1.6% at $66.81 a barrel.

Brent crude futures edged up 0.3% after dropping to $74.49 a barrel on Monday, their lowest in about three weeks. They were last at $75.53.

Spot gold was barely changed at $1,298.01 an ounce.