By Caroline Valetkevitch
NEW YORK (Reuters) - Stocks dropped and the euro fell to a more than six-week low on Monday after an uncertain outcome in Italy's elections raised concerns that harsh economic reforms in the region's struggling nations could stall and reignite the euro zone's debt crisis.
The U.S. benchmark, the Standard & Poor's 500 index, suffered its worst one-day percentage decline since November 7, while the euro fell more than 3 percent against the yen.
Investors sold Italian sovereign debt and flocked to benchmark U.S. Treasury bonds, pushing their yields to the lowest levels in a month.
Voting projections in Italy showed no coalition strong enough to form a government, raising the possibility of deadlock in parliament. That could paralyze a new government and reignite the euro-zone crisis.
Officials warned that such gridlock could make Italy ungovernable and could force new elections.
"Europe hasn't gone away as an issue. It is going to hang around, and it is rearing its ugly head today," said Stephen Massocca, managing director of Wedbush Morgan in San Francisco.
Italy's main stock index finished the day higher, but as details of the voting emerged following the European market close, an exchange-traded fund tracking Italy's market fell sharply, suggesting possible losses on Tuesday.
The iShares MSCI Italy Capped ETF ended the day down 5.7 percent.
With more than two-thirds of the vote counted, projections suggested the center left could have a slim lead in the race for the lower house of parliament.
The center-right coalition is led by former Prime Minister Silvio Berlusconi and has attracted substantial support from voters worried about austerity measures.
The MSCI world equity index fell 0.7 percent, reversing earlier gains.
Italy's main FTSE MIB stock market index rose 0.7 percent, but pared early gains of more than 3 percent, while the pan-European FTSEurofirst 300 index edged up 0.04 percent to close at 1,166.07. European markets closed before the latest vote totals.
On Wall Street, the Dow Jones industrial average fell 216.40 points, or 1.55 percent, to end at 13,784.17. The Standard & Poor's 500 Index was down 27.75 points, or 1.83 percent, at 1,487.85. The Nasdaq Composite Index was down 45.57 points, or 1.44 percent, at 3,116.25.
In the foreign-exchange market, the euro fell as low as $1.3077 on Reuters data, the lowest since January 10. It was last down 0.6 percent at $1.3096.
Against the yen, the euro fell as low as 120.88 yen, the weakest since January 25. It was last at 121.68, down 1.2 percent.
The uncertainty around the Italian elections adds a level of instability and risk back into markets that had mostly been gone, according to Jens Nordvig, chief currency strategist at Nomura Securities in New York.
"Political risk in the euro zone should not be ignored," he wrote in a note. "Lack of reform momentum in Italy may over time impact the (European Central Bank's) ability to backstop its bond market, implicitly and explicitly."
U.S. Treasury debt prices rose and benchmark yields slid to the lowest level in a month amid the uncertainty in Italy. The benchmark 10-year U.S. Treasury note was up 28/32, the yield at 1.8654 percent.
DOLLAR DOWN VS YEN
The dollar lost 1.7 percent to 91.75 yen, reversing early gains that drove it to a more than 33-month high of 94.76 yen, according to Reuters data.
The yen weakened after news that Japan's prime minister, Shinzo Abe, is likely to nominate an advocate of aggressive monetary easing, Asian Development Bank President Haruhiko Kuroda, as the next central bank governor to step up his fight to rid the country of deflation.
Abe's repeated calls for more forceful central bank action are largely behind the yen's nearly 20 percent loss in value against the dollar since November.
MORE GRIDLOCK AHEAD
The euro could continue to lose ground if risk appetite abates. President Barack Obama and the U.S. Congress remain deadlocked over how to prevent $85 billion in automatic government spending cuts set to start taking effect on March 1.
Investors also are looking ahead to testimony by Federal Reserve Chairman Ben Bernanke to Congress on Tuesday and Wednesday, in which he is expected to downplay the idea that the central bank could prematurely end its current massive monthly bond-buying program.
U.S. crude dipped 2 cents to $93.11 a barrel, while spot gold added 0.9 percent to $1,594.14 an ounce.
(Reporting by Caroline Valetkevitch; Additional reporting by Chuck Mikolajczak, Julie Haviv and Chris Reese in New York; Editing by Dan Grebler, James Dalgleish and Jan Paschal)