Investors were wary Wednesday after Italy's inconclusive elections gave a key role to an anti-austerity party that has ruled out joining a coalition government, setting the stage for a drawn-out stalemate.
"The outcome of the elections was even more confusing than we had anticipated," the Mediobanca investment bank said as Moody's warned it might downgrade Italy's debt rating, saying the vote result "increases the risk of political paralysis and prolongs political uncertainty".
The rating agency added: "This week’s elections have implications well beyond Italy itself and are, indirectly, credit-negative for other pressured euro area sovereigns."
European stocks began Wednesday's session in positive territory mainly due to the US Federal Reserve reaffirming its huge monetary easing scheme after sweeping losses on Tuesday but the eurozone was very much on investors' minds.
"Volatility will be the name of the game," Mediobanca Securities said in a note to investors as Italy's borrowing costs shot up on the debt markets.
"Election shock batters stocks, spreads" read the banner headline in Italy's financial daily Il Sole 24 Ore after Milan stocks plunged 4.89 percent on Tuesday, recovering slightly with a 0.62 percent rise at Wednesday's opening.
Leftist leader Pier Luigi Bersani on Tuesday admitted he had failed to win parliament -- without a majority in the Senate -- and warned that the country was in a "dramatic situation".
Bersani also made overtures to the newcomer Five Star Movement (M5S) led by former comedian turned anti-corruption firebrand Beppe Grillo, which won a massive protest vote from Italians fed up with austerity and the corruption of their political class.
But Grillo, who won about 25 percent of the vote, has so far ruled out joining any coalition. "The M5S is not allying with anyone," he posted on his blog.
Analysts said the options were few, including a loose alliance between the centre-left and M5S in the Senate, or an emergency government that could be formed to pass key reforms ahead of fresh elections.
Bersani urged basic reforms that everyone could agree on -- cutting government costs, reforming the labour market and helping the poorest as Italy endures its longest recession in two decades.
Leading Italian bank Intesa Sanpaolo warned of uncertainty for weeks ahead. "Given the technical timeline ... uncertainty may characterise the coming weeks," it said.
Under the constitution, parliament has to meet within 20 days of an election, after which formal negotiations begin with Italian President Giorgio Napolitano on forming a new government.
Moody's statement said: "We would consider downgrading Italy's government debt rating in the event of additional material deterioration in the country's economic prospects or difficulties in implementing reform."
Mediobanca said for its part: "We already had a defensive stance on the market ... and we now expect (higher taxes) to further depress consumption," adding: "We also expect widening spreads."
Also Wednesday, Italy's ISTAT statistics agency said that business confidence had dropped from 80 points in January to 77.4 points this month.
A coalition led by irrepressible tycoon Silvio Berlusconi confounded all poll predictions by coming in an extremely close second in the vote for the lower house, winning 29.18 percent to Bersani's 29.54 percent.
The scandal-tainted billionaire had promised to refund an unpopular property tax -- if necessary out of his own pocket.
Outgoing prime minister Mario Monti was the big election loser, taking just 10.56 percent in the lower house, the Chamber of Deputies.
His technocratic government, which replaced Berlusconi after he was ousted at the height of the financial crisis in 2011, won praise from other European leaders, but his austerity drive was unpopular at home.
Bersani admitted he had been "overtaken" by the protest vote for M5S, which became the biggest single party in parliament, but warned that the huge anti-austerity protest vote should be heeded beyond Italy's borders. "The bell tolls also for Europe," he said.
"We are aware that we are in a dramatic situation, we are aware of the risks that Italy faces," Bersani said on Tuesday in his first speech since the vote.
European leaders were quick to voice concern, with Spanish Foreign Minister Jose Manuel Garcia Margallo saying: "It's a leap into the unknown, which bodes poorly both for Italy and for the rest of Europe."