ROME (Reuters) - The Italian stock market fell and state borrowing costs rose on Tuesday as investors took fright at political deadlock after a stunning election that saw a protest party lead the poll and no group had a clear majority in parliament.
"The winner is: Ingovernability" ran the headline in Rome newspaper Il Messaggero, reflecting the stalemate the country would have to confront in the next few weeks as sworn enemies would be forced to work together to form a government.
In a sign of where that might lead, former prime minister Silvio Berlusconi indicated his center-right might be open to a grand coalition with the center-left bloc of Pier Luigi Bersani, which will have a majority in the lower house thanks to a premium of seats given to the largest bloc in the chamber.
Results in the upper house, the Senate, where seats are awarded on a region-by-region basis, indicated the center-left would end up with about 119 seats, compared with 117 for the center-right. But 158 are needed for a majority to govern.
Any coalition government that may be formed must have a working majority in both houses in order to pass legislation.
World financial markets reacted nervously to the prospect of a stalemate in the euro zone's third-largest economy with memories still fresh of the crisis that took the 17-member currency bloc to the brink of collapse in 2011.
The Milan bourse was down more than four percent at its opening and the spread between yields on 10-year Italian and German government bonds widened to 338.7 basis points, the highest since December 10. An ally of conservative German Chancellor Angela Merkel urged Italy to stick with reforms pursued by the outgoing technocratic emergency government of Mario Monti.
However, the poor showing by Prime Minister Monti's centrist bloc reflected a weariness with austerity that was exploited by both Berlusconi and comic Beppe Grillo; his anti-establishment 5-Star Movement won more votes than any other single party, taking 25 percent nationally. Bersani's allies helped his center-left bloc win the lower house by just 125,000 votes.
Berlusconi, a media magnate whose campaigning all but eroded Bersani's once commanding lead, said he was not worried about market reaction and played down the significance of the spread.
In a telephone call to a morning television show, he said: "Italy must be governed." He ruled out a deal with Monti but said he "must reflect" on a possible deal with the center left: "Every (political side) must be prepared to make sacrifices."
The euro skidded to an almost seven-week low against the dollar in Asia on fears about the euro zone's debt crisis. It fell as far as $1.3042, its lowest since January 10.
Another indication of investors' reaction to the results will come later on Tuesday when the Treasury auctions 8.75 billion euros in 6-month bonds.
Bersani claimed victory in the lower house and said it was obvious that Italy was in "a very delicate situation".
Grillo, however, showed no immediate willingness to negotiate. Commentators said all his adversaries underestimated the appeal of a grassroots movement that called itself a "non-party", particularly its allure among young Italians who find themselves without jobs and the prospect of a decent future.
"NON-PARTY" SURGES TO THE TOP
The 5-star Movement's score of 25.5 percent in the lower house was just ahead of the 25.4 percent for Bersani's Democratic Party, which ran in a coalition with the leftist SEL party, and it won almost 8.7 million votes overall - more than any other single party.
"The 'non-party' has become the largest party in the country," said Massimo Giannini, commentator for the Rome newspaper La Repubblica about Grillo, who mixes fierce attacks on corruption with policies ranging from clean energy to free Internet.
Grillo's surge in the final weeks of the campaign threw the race open, with hundreds of thousands turning up at his rallies to hear him lay into targets ranging from corrupt politicians and bankers to German Chancellor Angela Merkel.
In just three years, his 5-Star Movement, heavily backed by a frustrated generation of young Italians increasingly shut out from permanent full-time jobs, has grown from a marginal group to one of the most talked about political forces in Europe.
RECESSION
"It's a classic result. Typically Italian," said Roberta Federica, a 36-year-old office worker in Rome. "It means the country is not united. It is an expression of a country that does not work. I knew this would happen."
Italy's borrowing costs have come down in recent months, helped by the promise of European Central Bank support but the election result confirmed fears of many European countries that it would not produce a government strong enough to implement effective reforms.
A long recession and growing disillusionment with mainstream parties fed a bitter public mood that saw more than half of Italian voters back parties that rejected the austerity policies pursued by Monti with the backing of Italy's European partners.
Monti suffered a major setback. His centrist grouping won only 10.6 percent and two of his key centrist allies, Pier Ferdinando Casini and lower house speaker Gianfranco Fini, both of parliamentarians for decades, were booted out.
"It's not that surprising if you consider how much people were let down by politics in its traditional forms," Monti said.
Berlusconi's campaign, mixing sweeping tax cut pledges with relentless attacks on Monti and Merkel, echoed many of the themes pushed by Grillo and underlined the increasingly angry mood of the Italian electorate.
Stefano Zamagni, an economics professor at Bologna University said the result showed that a significant share of Italians "are fed up with following the austerity line of Germany and its northern allies".
"These people voted to stick one up to Merkel and austerity," he said.
Even if the next government turns away from the tax hikes and spending cuts brought in by Monti, it will struggle to revive an economy that has scarcely grown in two decades.
Monti was widely credited with tightening Italy's public finances and restoring its international credibility after the scandal-plagued Berlusconi, whom he replaced as the 2011 financial crisis threatened to spin out of control.
But he struggled to pass the kind of structural reforms needed to improve competitiveness and lay the foundations for a return to economic growth, and a weak center-left government may not find it any easier.
(Additional reporting by Barry Moody, Gavin Jones, Catherine Hornby, Lisa Jucca, Steven Jewkes, Steve Scherer and Naomi O'Leary; Writing by Philip Pullella and James Mackenzie; Editing by Pravin Char and Alastair Macdonald)
