Italian 10-year bond yields jumped the most in four months Monday in their first day of trading since Monti said on Dec. 8 that he planned to resign after former Prime Minister Silvio Berlusconi withdrew support for the government. The yield rose 29 basis points to 4.82 percent, while the benchmark FTSE MIB stock index slumped 2.2 percent, in contrast with gains in Germany, France and the U.K.

The market reaction will be “contained” and investors “shouldn’t fear any decision-making void,” Monti said at a press conference in Oslo. He will resign when Parliament passes his budget plan later this month and elections may be held as soon as February.

“I understand the market reaction, it need not be dramatized,” Monti said. “I’m very confident that Italian elections, when they come, will give room to a coalition or government that will be in my view a highly responsible, EU- oriented government, which will be in line with the huge efforts already pursued by Italy.”

Nobel Prize

Italy’s government crisis, which pits Monti against billionaire former premier Silvio Berlusconi, is roiling investors and bringing tensions among European Union leaders to the fore. Monti and other EU heads of state and government, who gathered in Oslo to collect the Nobel Peace Prize, are seeking to present a united front as the resurgent Berlusconi hits the campaign trail with his German-skeptic, anti-austerity message.

“The underlying cracks within the euro zone are actually widening,” Georg Grodzki, head of credit research at Legal & General Investment Management in London, which has about $290 billion of bond funds, said in an interview Sunday. “Investors will be reading Italian politicians’ lips very, very closely.”

The drop in Italian bonds widened the difference between yields between Italian debt and German bunds of similar maturity by 28 basis points to 351 basis points, the highest close since Nov. 19.

Italian banks were the hardest hit by the selloff in stocks with Mediolanum SpA, partly owned by Berlusconi, slipping 6 percent and Banca Monte Paschi dei Siena SpA shedding 5.9 percent. UniCredit SpA, the country’s biggest bank, lost 5.2 percent, the equivalent of about 5 billion euros of market value.

Budget Policy

The Italian election campaign puts the EU’s budget policy up for review in the 27-country area’s fourth-largest economy. Monti, 69, said Dec. 8 he will resign due to parliamentary opposition from Berlusconi and his allies, who had previously backed the government.

Under Italian rules, the election will likely be held between mid-February and mid-March. Monti will hand in his final resignation after making an attempt to muster parliamentary support for the 2013 budget law. A vote is due before the end of the year. Elections will be held 45 to 70 days after President Giorgio Napolitano dissolves parliament. In that interim period, Monti will likely remain premier.

Monti today dashed hopes of those who would like to see him enter the race for premier and take on Berlusconi.

Not a Candidate

“I am not considering this particular issue at this stage,” Monti said. “All my efforts are being devoted to the completion of the remaining time of the current government, which appears to be rather short but still requires intensive application of mind and energy on my part as well as my council of ministers”.

Under Monti’s 13-month-old government, Italy’s 10-year bond yield has declined more than 200 basis points and the government last month sold debt at the lowest rate in two years. His austerity measures, while deepening the country’s fourth recession since 2001, have also left the nation on track to bring its deficit within the EU’s limit of 3 percent of gross domestic product this year.

“Italy’s image has improved markedly thanks to the Monti government, and all that could be reversed,” Riccardo Barbieri, chief European economist at Mizuho International Plc in London, said in a research report today. Berlusconi “has repeatedly argued that the pros and cons of leaving the euro must be better analyzed and considered.”

EU Summit

At a summit in Brussels on Dec. 13-14, EU heads of government will debate a road map for the overhaul of the euro area, including increased powers to intervene in national budgets and the establishment of a single banking supervisor. Finance ministers will meet first, on Dec. 12.

Finding consensus in the EU may become more difficult without Monti, who overcame German resistance at a summit in June to broker a common pledge to aid members in financial distress. Berlusconi, who was pushed from power last year after proving unable to protect Italy from the debt crisis, announced Dec. 8 he will seek the premiership in next year’s election and criticized Monti for running a “German-centric” program.

“The 2013 Italian election remains high on our list of tail risks,” Holger Schmieding, chief economist at Berenberg Bank AG in London, wrote in a note yesterday. “A Berlusconi campaign against ‘German austerity’ could potentially unsettle markets.”

Italy’s economy shrank 0.2 percent in the three months ended Sept. 30, the fifth consecutive quarterly decline. The economy contracted 2.4 percent on an annual basis and household spending fell 4.8 percent from a year earlier.

Austerity Fatigue

Italy faces about two months of campaigning as Berlusconi, 76, seeks to reverse an opinion-poll slide by disavowing his ties to Monti and appealing to an electorate weary of tax increases and recession. Berlusconi’s People of Liberty party had 13.8 percent support in an SWG Institute poll released last week, compared with 30.3 percent for Monti’s biggest remaining backer, the Democratic Party.

Berlusconi, who was sentenced in October to four years in prison for tax fraud, is free pending appeal. In an unrelated case, he is standing trial on charges of abuse of power and engaging a minor in prostitution, allegations he has denied.

“The ability of Silvio Berlusconi to spook investors knows no bounds,” Nicholas Spiro, managing director of Spiro Sovereign Strategy in London said in an e-mailed message. “Mr. Berlusconi is not the cause of Italy’s deep-seated and long- standing economic problems, but he epitomizes the dysfunctional nature of Italian politics, with its discredited leaders and unstable governments.”