European stock markets made a modest recovery and returns on Italian government bonds fell back on Wednesday as fears over political turmoil in the eurozone’s third-largest economy eased.
The benchmark Italian share index rose 1.4%. London and Frankfurt were also higher after sharp falls on Tuesday.
However, shares in French banks fell amid fears about their exposure to Italy.
An auction of Italian five and 10-year government bonds is being held later.
If the sale fails to go smoothly it could raise questions about Italy’s ability to refinance its national debt.
Reports on Wednesday said that the anti-establishment 5-Star Movement and far-right Northern League had renewed efforts to form a coalition government after the president rejected their choice for the economy ministry over the weekend.
The parties were trying to find “a point of compromise on another name” after the rejection of arch eurosceptic Paolo Savona for the ministry.
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Barclays investment strategist Hao Ran Wee said the bond market would act as a curb on the parties’ spending plans: “No investor would lend to the Italian government if they deem it as being unable to pay back its debt.”
Wednesday’s bond auctions will be the first real test of investor sentiment since the political crisis erupted, said DZ Bank strategist Daniel Lenz.
“If auctions begin to fail because of lack of demand, Italy would be at risk of losing market access and this is what we really have to look out for today.”
On Tuesday the yield on two-year Italian bonds posted the biggest daily jump in 26 years, hitting a high of 2.83%.
The yield fell back to around 2.5% on Wednesday.
The return on 10-year Italian government bonds remains more than 3%, compared with about 0.324% for the German equivalent – deemed to be the safest in the eurozone.
Earlier markets in Asia fell, with the Nikkei in Tokyo falling 1.4%, South Korea’s Kospi down more than 1.8% and Hong Kong’s Hang Seng 1.4% lower.
The falls in Asian stocks mirrored losses in the United States on Tuesday night, when the S&P 500 fell 1.2% and the Dow Jones ended 1.6% lower.