It's deja vu in the euro zone. The events that have unfolded in Italy over the last three months hark back to 2011-2012, when the crisis in southern Europe, centred on Greece, came to a head and led to a market meltdown. Only this time, the country engulfed by crisis happens to have the third largest economy in the euro zone. Italy's crisis is multi-dimensional - economic, financial, political and constitutional. The trigger was the election of March 4 which produced a hung Parliament. After two months of political wrangling, an unlikely coalition of two radical parties from opposite ends of the political spectrum, The League and the Five Star Movement, were invited to form a government. However, Italy's President Sergio Mattarella vetoed the coalition's choice of Finance Minister Paolo Savona, a known eurosceptic, who once advocated abandoning the euro. The President then appointed a caretaker government led by former International Monetary Fund official Carlo Cottalleri.
The outraged coalition leaders have called for demonstrations against the President. As all this was unfolding, financial markets took fright. The yields on Italian 10-year bonds rose to their highest level in four years, while two-year yields surged the most since the inception of the euro. The stocks of European banks, which are known to be substantial holders of Italian debt, tanked. The euro has tumbled, and US Treasury bond yields have fallen, signalling a flight to safety.
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