Investors panic at prospect of scandal-prone former Premier's political revival.

The spectre of another Berlusconi premiership has panicked the financial markets and has Italy and the euro staring into the abyss again.

Within hours of opening yesterday, Milan's stock exchange had fallen nearly 4 per cent and Italy's borrowing costs shot up as markets tried to make sense of the chaotic political scene after Prime Minister Mario Monti's announcement at the weekend that he plans to resign.

By close, Italy's main FTSE MIB stock index had fallen 2.2 per cent to 15,354.

"The underlying cracks within the eurozone are actually widening," said Georg Grodzki, an analyst with Legal & General Investment Management in London. "Investors will be reading Italian politicians' lips very, very closely."


Monti insisted he was not considering running for office in elections early next year, despite building speculation that he was planning to continue in government in some capacity. Monti said on Sunday that he planned to step down after passing the 2013 budget.

"I am not considering this particular issue at this stage," Monti, 69, said at a press conference in Oslo, where he joined other European Union leaders to pick up the Nobel Peace Prize. "All my efforts are being devoted to the completion of the remaining time of the current Government, which appears to be a rather short time, but still requires an intensive application of my energies."

La Stampa newspaper had speculated he might attempt to form a new grouping in the political centre in an effort to continue his reforms, which have stabilised Italy's finances since he took over from Silvio Berlusconi's collapsing Government 13 months ago.

Other pundits have predicted that he will endorse another political grouping that backs his reforms or seek a high-profile position - perhaps economics minister in a centre-left government.

The ex-Premier Berlusconi - whose party prompted the current crisis by withdrawing its support in two votes last week - was attempting to mend ties with the anti-immigration Northern League, whose support he would desperately need in a centre-right coalition.

Over the past few months the 76-year-old media mogul has stepped up his populist attacks against the EU, Germany and austerity measures. Senior figures in Europe warned that Monti's policies had to continue to avert the return of the crisis that brought him to power a year ago. Only then would a Greek-style collapse be averted, they said.

"Monti was a great Prime Minister of Italy and I hope that the policies he put in place will continue after the elections," European Council President Herman Van Rompuy said in Oslo.

The Spanish Finance Minister, Luis de Guindos, said that instability in Italy could spill over and put further strain on Spain's public finances.

But with Berluscon's PDL behind in the polls - it has just 18 per cent against the centre-left Democratic Party's 38 per cent - the tycoon's chances of winning a fourth election appear marginal at best.


What is happening in Italy?
New strains: The prospect of a return to a shaky government and shakier finances in Italy has put new strains on the leaders of the group of 17 European Union countries that use the euro.

Rougher ride: Italy's Prime Minister Mario Monti has confirmed he will resign, pulling the plug on a 13-month-old government that has boosted confidence in the country's ability to manage its debts.

Spreading woes: Analysts warn that after several months of calm, the eurozone could be in for a rougher ride. The concern is that Italy's problems will spread and further unsettle other parts of the eurozone.