FRANKFURT -- Italy's political turmoil has sent a wave of concern through the 19-nation eurozone that the country could be heading toward a new financial crisis -- and even, in a worst case, out of the euro currency.
One big reason for the worry: the firewalls the eurozone built to prevent a rerun of its 2010-2012 debt crisis largely depend on countries being willing to go along with the currency bloc's financial rules.
And that's the last thing Italy's populist parties say they want to do.
Bond markets shuddered Tuesday, sending the yield on Italy's two-year bonds sharply higher -- a sign investors think the bonds have suddenly become riskier investments. The two-year yield more than doubled, from under 1 per cent to 2.2 per cent.
That's a huge jump for one day, and brought back bad memories of 2011, when skyrocketing government borrowing costs threatened to break up the euro and helped drive then-Premier Silvio Berlusconi from office.
That crisis was calmed in large part by the European Central Bank and the now famous promise by its president, Mario Draghi, to do "whatever it takes" to save the euro. In practical terms, the bank in 2012 proposed to step in and support countries facing extreme borrowing costs by buying their government bonds.
The ECB, however, reminded everyone Tuesday that such help would come with strings attached, like controls on government spending.
"The rules are very clear on this," the ECB's vice-president, Vitor Constancio, said in an interview published online Tuesday by Der Spiegel magazine. "Italy knows the rules. They should perhaps take another close look at them."
Spending controls imposed by the European Union are the kind of external oversight that Italy's populist politicians have criticized and that prompted political rebellion in bailed-out Greece.
Italy's populist 5-Star Movement and the anti-immigration League have criticized European Union restrictions on annual government borrowing and on the overall size of a country's debt pile. Italy has the heaviest debt load in the eurozone outside Greece, worth 132 per cent of annual economic output. The 5-Star and League have proposed tax cuts and spending plans, like a basic guaranteed income for the poor, that would risk breaching those rules.
That means that avoiding a new euro crisis largely hinges on the hope that Italy's populist politicians don't mean what they say and won't engage in budget-busting spending if they win a new election, expected as soon as September.
For sure, the eurozone is in a much better place than it was in 2010-2012, making it more resistant to financial trouble.
Deficits are lower, economic growth is stronger, and more people have jobs. Borrowing costs for Italy, as for other eurozone countries, are so low that it would take a much more drastic increase to endanger the Italian government's ability to borrow and repay its bonds as they come due. In particular, the European Central Bank's monetary stimulus, under which it buys government bonds, has driven governments' borrow rates to very low levels across the eurozone.
The yield on Italy's 10-year bond rose by about 0.4 percentage point to 3.1 per cent. While that's a four-year high, it's still well below the 7 per cent rate that precipitated Italy's crisis in 2011.
Yet a 5 Star-League government might double down on anti-euro rhetoric and make the next Italian election a referendum on the euro. And if they win and carry through on policies that worsen Italy's debt, investors might take fright and demand much higher rates to lend to the country.
In any case, Italy now faces weeks or months of uncertainty under a stopgap government. Efforts to form a government collapsed Sunday after President Sergio Mattarella rejected a nominee for economy minister, Paolo Savona, who in the past had entertained a "Plan B" to leave the euro.
"A continuing sharp sell-off may force Italy to clarify its political situation fast, ideally with the radicals vying for power clarifying for good that they would not jeopardize Italy's position in the euro," said economist Holger Schmieding at Berenberg bank. "Unfortunately, they do not seem anywhere close to doing that. One way or the other, things can potentially come to a head fast in an acute crisis."
"Only Italy can save itself from a crisis by a credible commitment to follow the rules of the euro in the future. We expect Italy to stay in the euro, with only a small tail risk of an Italexit," or Italian departure from the euro.
Analysts at the Peterson Institute for International Economics said in a blog post that "none of the powerful stabilization instruments that the euro area has developed over the years could be deployed to rescue Italy."
Access to the eurozone bailout fund, the European Stability Mechanism, would be conditional on restrained spending, the opposite of what the populist parties have promised. Unless such a government was to change course, "it would be forced to exit the euro, even if this is not the plan."
The authors said an Italian exit from the euro is still not likely, in part because so much Italian debt is held by Italians. That means any default would hit the governments constituents as hard as foreign investors.
The euro might survive an Italian exit, but it would "put Italy, the euro area economy and the European Union in deep distress."
