Beppe Grillo, whose populist movement was the top vote-getter in Italy's election this week, rejected a call by Democratic Party leader Pier Luigi Bersani to back a coalition.
To have any chance to govern, Bersani's bloc needs to bring in Grillo or join with former prime minister, Silvio Berlusconi, who lost to Bersani by less than half a percentage point in the lower house. No coalition was able to obtain a majority in the Senate.
Grillo, whose Five Star Movement has rejected allying itself with established parties, "won't give any vote of confidence to the PD or others", he wrote on his blog yesterday. "It will vote on the laws that reflect its own programme, no matter who puts them out. If Bersani wants to propose the abolition of public funding to parties including funds for the past election, we will vote in favour of it straight away."
The prospect of a hung parliament and concern the country may need new elections roiled markets, with the benchmark FTSE MIB stock index shedding almost 5 per cent yesterday and bond yields rising.
Bersani yesterday said Grillo's movement must outline their plans.
"Until now they have been saying that everyone must be sent packing, but now they are here too, so they must say what they want to do for this country and for their children," Bersani said.
Berlusconi dismissed new elections as not useful and said he would consider an alliance with his rival. Bersani rejected the olive branch, saying he would not seek any deal with Berlusconi before the new parliament convenes on March 15.
Recession-scarred voters rejected the budget rigour that Bersani and Berlusconi had backed as part of Prime Minister Mario Monti's unelected government. The economic pain that Monti delivered helped make Grillo, a former comedian, into a political force. The risk for Italy is that a weak government will leave Europe's second-biggest debtor, after Greece, vulnerable to financial turmoil.
"It appears that euro zone political uncertainty is back and investors should expect higher volatility as more weight is placed on political news flow," said Azad Zangans, an economist at Schroders Investment Management.
An alliance between Bersani and Berlusconi runs the risk of allowing Grillo to remain the only main opposition party, free to cull popular anger to build even more support.
"If they don't change strategy and go vote again with similar candidates, the risk is a Grillo landslide," Giovanni Orsina, a history professor at Luiss Guido Carli University in Rome, said.
An Italian government requires a majority in both houses, which have equal powers. Current rules make it difficult for a party to win both. In the lower house Chamber of Deputies, the coalition gaining the most votes automatically gets 54 per cent of the seats. The Senate is apportioned regionally.
Italian President Giorgio Napolitano yesterday cancelled talks with the man bidding to unseat German Chancellor Angela Merkel after he called two Italian political players "clowns".
Commenting on the inconclusive vote in Italy, Peer Steinbrück said he was "downright appalled that two clowns won" - a reference to the big votes won by Grillo and scandal-tainted former premier Berlusconi.