With the spending plans putting the Italian government on a collision course with the European Commission, Milan took the brunt of the blow in equity markets, dropping by more than 4.6 percent at one point and ending the session 3.7 percent lower.
Thursday's budget deal that calls for a 2.4 percent deficit for the next three years came after warnings from the EU to rein in spending and it vastly exceeds the 0.8 percent deficit foreseen by the previous, center-left government.
“The Italian budget continued to cast a shadow over the markets on Friday, setting up a rocky end to a rocky month,” noted Connor Campbell, financial analyst at Spreadex trading group.
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“Investors are distancing themselves from Italian bonds and stocks, and risk-off sentiment is spreading across Europe,” said market analyst David Madden at CMC Markets UK.
“The severe sell-off in European financial stocks is reminiscent of the eurozone debt crisis,” he added.
The trading of shares in some Italian banks was briefly suspended amid heavy price falls, with Banco BPM leading the way down with a drop of 9.4 percent.
The top two Italian banks, UniCredit and Intesa Sanpaolo, lost 6.7 and 8.3 percent respectively.
Shares prices of major European banks outside Italy also slumped, with French lender Credit Agricole down 4.4 percent, Deutsche Bank sliding 3.8 percent and Barclays losing 2.8 percent.
Meanwhile, the yield on Italian government bonds jumped and the euro also dropped heavily against the dollar.
Italian government bonds “have unsurprisingly been under pressure” said analysts at UniCredit in a note to clients.
The spending plan “creates several important challenges, from a confrontation with the EC to the possibility of a downgrade of the sovereign credit rating,” they said, adding that volatility in Italian bond prices was likely to continue, especially as the European Central Bank winds down expanding its purchases of government bonds.