Share prices in France, UK and United States came under strong pressure on Monday (September 30), hit by fears the uncertain outcome of Italy's political situation could propel the euro zone back into a crisis many were hoping it was recovering from.
By 1030 GMT, the French CAC-40 index stood at 4,133.70 points with a loss of 1.27 percent, while London's FTSE lost 0.9 percent and falling to 6,456.79 points by 1050 GMT.
"Actually the uncertainty will probably be there for a while in Italy, till we have a bare vision of what will be the situation in the next month. The risk is now high that this government will fall and so we can't exclude an early election which could result to a stalemate, the same that we have seen earlier this year. So it's a worrying situation in Italy and the markets have a negative reaction this morning," said Jeremy Gaudichon, a fund manager at KBL Richelieu in Paris.
For the third time since 2011, Italian President Giorgio Napolitano is trying to steer the country out of political chaos that has proven a major threat, not only to the euro zone's third-largest economy, but to the region's efforts to halt its four-year debt crisis.
The latest turmoil was set off on Saturday when the five Cabinet ministers who are from Berlusconi's party suddenly stepped down, leaving the government only formally in place.
Letta will go before parliament on Wednesday and hold a confidence vote to verify what is left of his parliamentary backing.
The political jockeying that will ensue will inevitably take Rome's attention off the important structural reforms that Italy needs to adopt in order to cure its economic ills and become a stronger player within the European Union.
"When it comes to the Italian issue, we have this vote of confidence by the PM Enrico Letta on Wednesday and I think investors are looking forward to that to see where we are going next. It seems that they are going to try their best to work out a new coalition government and if that doesn't happen and it's new elections. And if there's new elections then there's going to be a lot of worries on the market going forward," said Ishaq Siddiqi, a market analyst at ETX Capital.
Two years ago, Italy risked taking the euro zone's debt crisis to a boiling point, when its borrowing costs soared because of a lack of confidence that the then-Berlusconi government could bring down the country's 2 trillion euro debt.
Since 2011, the European Union has adopted several policies aimed at preventing a repeat of the debt crisis. Notably, a pledge made in September 2012 by the European Central Bank that it would step in to avoid another flare-up has eased investor concerns about the solidity of the euro zone.
However political instability has cost Italy dearly. The country's borrowing costs hit a three-month high at an auction of 10-year bonds on Friday, while the premium investors demand to hold Italian debt rather than German paper widened to about 267 basis points from under 250 at the start of the week.
Presented by Adam Justice