Italy bond yields jump, stocks sink on Monti's early exit

"If the spread goes back above 400-450 basis points, Italian banks will find it very difficult to access the wholesale market," said a senior Italian economist.

Italy will have completed its refinancing for the year after this week's debt auctions, which remain on schedule despite Monti's move, a source close to the treasury told Reuters.

BANKS HIT HARD

Italian shares dived more than 3 percent, with banks hit hard due to their hefty domestic government bond holdings. <.FTMIB>

Banca del Monte dei Paschi di Siena , the weakest of Italy's five systemic banks, fell more than 6 percent and was suspended at one point due to excess volatility.

The bank needs parliament's green light for nearly 4 billion euros (3.22 billion pounds) of state aid. Its last chance to get the aid is if this is approved together with the budget law, the final parliament act Monti is ready to oversee before quitting.

Betting against Italy while the government is a lame duck made it an easy game for speculators and more turmoil is to be expected, bankers said.

The picture could be further complicated if international ratings agencies that have already placed Italy under review for a possible downgrade were to pull the trigger.

Still, analysts and senior Italian bankers say market jitters would abate if it becomes clear the Italians will elect a pro-Europe government, as polls currently indicate.

"At present, the most probable outcome remains that of a centre-left coalition government, with Monti involved in some institutional role. This would broadly see a continuation of policies introduced by the Monti government," said Francesco Garzarelli, an analyst at Goldman Sachs.

Monti, called in a year ago as a technocrat prime minister to replace Berlusconi and guide Italy out of an acute financial crisis, has not yet decided whether he will continue to play a political role.

European Council President Herman Van Rompuy said on Monday that whoever replaces him must keep pressing ahead with similar reforms and budget consolidation efforts to restore confidence and stability both in Italy and the euro zone.

"There is a lot of noise right now, and it will continue for a few days. But in practice not much has changed and we are heading towards a centre-left, pro-Europe government," said a top Italian banker. ($1 = 0.7735 euros)

(Writing by Lisa Jucca; Additional reporting by Francesca Landini; Editing by Hugh Lawson)