* MSCI World index down 0.6 pct
* Euro hits 7-week low before recovering
* Italian bond yields rise by most this year
* U.S. stocks seen higher as Bernanke testimony eyed
By Richard Hubbard
LONDON, Feb 26 World stock markets and southern
European government bonds sank on Tuesday on fears that
political gridlock in Italy would leave its economic reforms in
tatters and reignite the euro zone's broader debt crisis.
However, U.S. stocks, which fell in reaction to the Italian
election outcome on Monday, were poised to open higher, with
investors awaiting testimony by Federal Reserve Chairman Ben
Bernanke on future policy direction.
But the uncertainty generated by the Italian poll was still
rattling most other major risk asset markets, with Italy's
10-year bond yields, which rise as prices fall, up as much as
half a point to 4.86 percent, their highest since mid-December.
Investors also sold Spanish and Portuguese debt and sent
Brent crude oil prices down to $113 barrel, their lowest level
in a month, while safe-haven assets like gold and German
government bonds rallied.
"The main driver now is the deadlock after the Italian
election - it's triggered risk-off sentiment in the financial
markets," said Carsten Fritsch, commodity research analyst at
Commerzbank in Frankfurt.
Investors are fearful that the strength of the vote for
anti-austerity parties at the election will weaken efforts to
reform Italy's public finances and its labour laws, damaging the
euro zone's efforts to resolve its three-year old debt crisis.
"What's important is to understand if, in fact, this (vote)
against austerity is also against reform, which clearly is still
very important to Europe, and to Germany as well, with the
elections coming in September," said Virginie Maisonneuve, head
of Global Equities at Schroder Investment Management.
Last year's promise by the European Central Bank to provide
unlimited support to struggling euro zone nations provided some
reassurance to investors, allowing many to wait for greater
clarification on Italy's next step.
"A lot of our clients are in a 'wait and see' mode looking
to sit on their current holdings to see how the situation
develops," said Lyn Graham-Taylor, fixed-income strategist
"Obviously they will become active once the political
situation becomes clearer," he said.
Italy and Spain's need to change the shape of their
economies, get growth going and debt down have been at the heart
of the euro zone's troubles for more than a year, but the fears
have eased substantially since the ECB made its support clear.
The uncertainty weighed on European share markets, dragging
the pan-European FTSEurofirst 300 index down nearly 1
percent. London's FTSE 100 was down 1.25 percent, while
Paris's CAC-40 and Frankfurt's DAX were down as
much as 1.7 percent.
MSCI's broadest index of Asia-Pacific shares outside Japan
fell 0.9 percent, sending the MSCI world equity
index down 0.6 percent to 349.1 points.
The inconclusive outcome in Italy cast a further shadow over
the euro, which had hit a high of $1.37 at the start of the
month before steadily losing ground as economic data showed the
region's economy still struggling.
The euro traded around $1.3050 on Tuesday, just above
seven-week lows, while against the yen its was up 0.4 percent at
"We have seen a cautious bounce (in the euro), but it
doesn't look like we are seeing anything durable here," said
Jeremy Stretch, head of currency strategy at CIBC.
Investors were also nervous before testimony later in the
day from U.S. Federal Reserve Chairman Ben Bernanke, who could
give further clues to when the central bank intends to slow down
or stop its bond-buying programme.
Financial markets were rattled last week when minutes of the
Fed's January meeting showed some officials were thinking of
scaling back its monetary stimulus earlier than expected.
Also of concern to many is the darkening outlook for global
growth, with sharp budget cuts due to take effect in the United
States on Friday, and weak data from China revealing a growing
slowdown in its export-oriented manufacturing sector.
The uncertainty has led to a sharp rise in volatility, with
the CBOE's widely watched Vix Index jumping 34 percent on
Monday for its biggest one day gain since August 2011.
Europe's equivalent index, the VSTOXX, which
reflects options pricing and demand to protect against falls in
the underlying cash market, rose 15 percent on Tuesday to hit a
new year's high of 24.73.