Italy's populist government has defied Brussels by pressing ahead with a spending splurge and now faces the "big risk" of being downgraded by credit ratings agencies, economists fear.
Share prices in Italian banks, which are large holders of the nation's debt, dropped heavily on Friday.
The fall appeared to confirm fears that the "doom loop" link between financial systems and government bonds remains strong in the eurozone a decade on from the financial crisis. The impact was also felt across Europe with falls in German and French markets.
The country's credit rating is currently only two ranks above so-called junk bond status.
Investors have grown increasingly concerned about Italy's debt burden and the wider implications for the eurozone bloc.
Spending plans unveiled by the government are now heightening fears that Italian debt could spiral out of control in order to fund a lower retirement age, citizens' income, and lower taxation.
The FTSE MIB, the benchmark for the Italian national stock exchange, fell 4.4 per cent in Friday's trading before recovering slightly, in the wake of the proposed budget. Spreads between 10-year German and Italian bonds, used as an indication of the relative risk of debt, widened considerably to a three-week high to reach 273 basis points.
David Owen of Jefferies International said: "The European Central Bank won't do anything [to help stabilise the economy] at the moment. They will hope that bond spreads will keep opening out putting pressure on government to correct things.
"I think the big risk would be if one of the ratings agencies comes out and downgrades Italy and then everyone will be [watching for an Italian exit from the EU]."
The proposals, which must be voted through by parliament, have been put forward by the populist coalition of The Lega and Five Star parties. They outline a 2.4 per cent deficit, triple the 0.8 per cent deficit put forward by the previous government and places the nation's leaders on a collision course with Brussels.
The deficit level was a significant defeat for the independent technocrat economy minster Giovanni Tria, who was understood to be aiming for a figure of 1.6 per cent.
"It is a budget which appears to be beyond the limits of our shared rules," EU Commissioner Pierre Moscovici told Italian radio stations BFMTV and RMC on Friday.
Rules on eurozone member budgets set a limit of 3 per cent of deficit spending. However, due to Italy's very high debt of 131 per cent of its economic output, in this case that level was "not a target but a roof", Moscovici told financial newspaper Sole 24 Ore last month.
The EU has a 60 per cent ceiling on public debt under the Maastricht treaty. Many other EU nations have also breached this level, with French debt to GDP at 99 per cent.
Brussels is likely to take a different attitude towards Italy's target busting debt, however. The country's debt-to-GDP ratio is second only to Greece in the eurozone currency bloc, and it is a far larger economy.