

MILAN—Investors hammered Italian stocks, bonds and government securities early Tuesday after the country's election produced an uncertain outcome, raising the prospect that Italians may have to return to the polls and sparking fears of a renewal of the euro-zone crisis.

Investors are keeping a close eye on statements from party leaders to see whether they can form a broad-based coalition.

At 0623 ET, Italy's FTSE Mib stock index was down 4.48%, while yields on Italian 10-year benchmark bonds was up 0.31 percentage point at 4.69%, after trading as high as 4.88%.

The euro, which had strengthened since the summer on hopes of a stabilization of the euro zone's problems, hit a seven-week low against the dollar before stabilizing, while Italy's borrowing costs soared at an auction of six-month securities.

A slate of Italian stocks failed to open amid heavy selling. When they did, virtually all stocks were down, led by banks including UniCredit SpA and Intesa Sanpaolo SpA.

"Political instability is taking a toll on government bonds, which Italian financial companies are stuffed with, so they are the ones which suffer most," said Vincenzo Longo, a strategist at IG Markets in Milan.

Italian market regulator Consob said it has instituted a ban on short selling of Intesa Sanpaolo shares. The body has in the past ordered bans on short-selling when Italian stocks have come under heavy downward pressure.

Assicurazioni Generali SpA, Italy's largest insurer by assets which has a large government bond portfolio, was also hit hard.

With the count going through the night, investors woke to what some described as the worst outcome—the prospect that no party or coalition would be able to form a stable government. The coalition led by the center-left Democratic Party won a slim margin in the lower house, beating the center-right coalition of former prime minister Silvio Berlusconi and therefore automatically being awarded a majority of seats.

But due to the strong showing of Beppe Grillo's anti-establishment Five-Star Movement, no party won enough votes to command a clear majority in the Senate. As a result, investors fear a lengthy period of political deadlock that will dash any hopes of reforms and could even lead to a new vote.

The result was a sharp rebuke after months of rising optimism about the euro zone's prospects among international investors, when many even bought into securities in the region's troubled southern rim on the bet that the worst was over.

Italy's borrowing costs leapt to a four-month high at a sale of short-dated government securities on Tuesday. Italy sold €8.75 billion ($11.47 billion) of six-month Treasury bills at an average yield of 1.237%, up from 0.731% at the previous sale on Jan. 29 and the highest at an auction since Oct. 29., 2012.

Investors will look to the result of Wednesday's auction of 10-year benchmark bonds, with some expecting yields of more than 5%. After that, investors may hold their positions as they await the outcome of consultations between the parties and the Italian president—expected to take several weeks—to determine what happens next.

Carlo Aloisio, a futures and options vice president at UniCredit in Milan, said investors are awaiting the reaction of Italy's political leaders to the gridlock election result before deciding what to do next with their positions in the market.

Markets are monitoring statements from party leaders to see whether they can form a broad-based coalition that would be charged with changing the electoral law, widely considered to contributing to the instability of Italian governments.

In that case, Italians would return to the polls with an electoral law that could produce a government that is stronger and more capable of passing much needed market reforms. While such an outcome would take months to play out, it could ultimately boost Italian securities, say analysts.

Barclays said in a research note that the formation of a grand coalition in parliament was the best solution. "Italy cannot risk being trapped in a political impasse for too long," it said.

Pier Luigi Bersani, head of the Democratic Party, is due to hold a news conference at 1100 ET. Meanwhile, Prime Minister Mario Monti is meeting with Economic Minister Vittorio Grilli and Bank of Italy Governor Ignazio Visco. A statement from the premier's office offered no other details of the meeting.