Italy's ongoing political paralysis worsened Wednesday, overshadowing fears that the financial meltdown in Cyprus could be repeated in other small eurozone states.
A month after an inconclusive election, Italy is still no closer to a new government after the third-place 5-Star Movement rejected Pier Luigi Bersani's latest request to form a coalition with his first-place Democratic Party.
Bersani has vowed not to team up with Silvio Berlusconi's No. 2 right-wing bloc, raising the chances of another election. The former prime minister is already whipping up supporters in anticipation of a snap vote, perhaps in the summer or fall.
The spread between Italian and German benchmark 10-year bonds widened to the biggest margin in four months. Rome's latest bond auction also saw weak demand. Spanish 10-year yields moved back above 5%.
U.S. investors again shrugged off Europe's latest woes. The major averages sold off early in the stock market Wednesday, but rallied to close little changed.
Despite the recent drama over Cyprus' bailout, Italy and Spain are still the biggest causes for concern in Europe, said Nariman Behravesh, chief economist at IHS Global Insight.
But even if Italy's politicians somehow form a government, the fact remains that about two-thirds of voters are against the austerity and structural reforms the country needs, he noted.
"The issue is the Italians don't want it," he said. "I don't know how you resolve that.
Spain's budget deficit last year was revised to 6.98% of GDP from 6.7%, and the gap so far in 2013 appears on track to exceed the 3.8% target for this year.
The economy, like Italy's, is stuck in a severe recession, and Spain's central bank predicted Tuesday that the unemployment rate could reach 27% this year. A sovereign bailout for Madrid, following last year's bank rescue, is inevitable, Behravesh said.
Problems in the No. 3 and No. 4 eurozone economies lingered as concerns grew over the currency union's smallest members. Leaders of Luxembourg, Malta and Slovenia denied that they could be the next Cyprus, which will get a 10 billion-euro international bailout after imposing steep losses on bank shareholders, creditors and large depositors.
While Slovenia has a small financial sector next to Malta's and Luxembourg's, the former Yugoslav republic's loss-ridden banks may need to be restructured into "good" and "bad" ones the way Cyprus' top two lenders will be.
The Cypriot central bank said banks will reopen Thursday after being closed for nearly two weeks. Details also emerged on capital controls, the first ever in the eurozone.
The measures will apply to all banks and include limits on electronic fund transfers out of the island tax haven, cash travelers can take overseas, credit card purchases, check cashing and foreign trade transactions. A cap on ATM withdrawals is expected to remain but with a higher maximum.
The government said the controls will last four days, but analysts see them extended for at least several months, pointing out that Iceland's have been in place since 2008.