European markets have rallied at the news but analysts warned this upturn could prove short-lived with new elections now likely, adding more uncertainty to the political situation in the Eurozone’s third largest economy.
Italian president Sergio Mattarella shocked the international community after rejecting the coalition’s finance minister candidate, 81-year-old eurosceptic economist Paolo Savona, over his threats to pull Italy out of the Eurozone.
In an attempt to move Italy back closer to Brussels, President Sergio Mattarella summoned Carlo Cottarelli to his office earlier today. Mr Cottarelli, a former IMF director is now tasked with forming a pro-EU technocrat government in Italy, despite the country's palpable anger against institutions like the IMF and European Central Bank, and the deeply unpopular austerity measures imposed in 2011.
On the coalition's move towards the Eurozone's first Eurosceptic government, President Mattarella said: “Membership of the euro is a fundamental choice. If we want to discuss it, then we should do so in a serious fashion.
“The uncertainty over our position has alarmed investors and savers both in Italy and abroad.”
Lega Nord and Five-Star have labelled the rejection of the election’s result as “madness.”
The coalition had spent days drawing up a pact aimed at ending a stalemate following an inconclusive March vote and now claim President Mattarella has abused the power of his office.
Lega Nord chief Matteo Salvini has now threatened chaos and mass protests unless snap elections were called, while Five-Star leader Luigi Di Maio called on parliament to "impeach President Mattarella.”
Mr Salvini said: “If there’s not the OK of Berlin, Paris or Brussels, a government cannot be formed in Italy. It’s madness, and I ask the Italian people to stay close to us because I want to bring democracy back to this country.”
The Eurozone’s largest economy Germany reiterated its desire for Italy after the Germany’s EU minister Michael Roth said: “We hope that Italy will have a stable, pro-European government soon.
“In Germany we should refrain from giving advice about government formations, as it took us six months as well to form a coalition.”
European financial markets had tumbled last week on fears the coalition being discussed - a marriage of the far-right Lega Nord and the populist 5-Star Movement - would unleash a spending splurge and dangerously ramp up Italy’s already huge debt, which is equivalent to more than 1.3 times the nation’s domestic output.
Financial leaders in the EU will now look to use the Italian president's move to push for a political nullification of the coalition dialogue after markets rallied on the news that Italy’s economy, the euro zone’s third-biggest, would not be guided by a government hostile to the single currency.
Michael Leister, Commerzbank strategist said: “We are seeing a decent relief rally in European markets, starting with the euro overnight, with the risk of an anti-euro finance minister in Italy being averted.”
However he then warned another round of elections might not deliver a different result.
He said: "Salvini could emerge as a stronger figure at the end of that. It’s quite telling that Moody’s highlighted structural risks on Friday."
As Italy’s democratic crisis gather pace, Mr Salvini said in a radio interview he would seek parliamentary support from 5-Star to change the electoral law. The current purely proportional system produced a hung parliament two months ago, and polls suggest it could happen again.
Lega Nord, which won 17 percent of the vote in March, would surge in any early ballot, polls show, while support for 5-Star remains above 30 percent.
Mainstream centre-left and centre-right parties are losing further ground in the face of voter anger over the sluggish economy, high unemployment and rising poverty.
Demanding an immediate ballot, Mr Salvini told followers on Facebook: “It won’t be an election, it will be a referendum between Italy and those on the outside who want us to be a servile, enslaved nation on our knees.”
However, Salvini dismissed calls on Monday by 5-Star and a far-right ally, the Brothers of Italy, to chase Mattarella out of office.
Brothers of Italy chief Giorgia Meloni said: “We will ask parliament to charge Mattarella with high treason because he has acted under foreign pressure.”