A sharp rally in Italian government bonds and shares could be in jeopardy as scandal-plagued former premier Silvio Berlusconi gains ground in polls, putting investors’ bets on a centre-left election victory at risk.

A reform-friendly coalition of centre-left parties is still expected to win most seats at the February 24-25 election, but recent polls showed a right-wing bloc led by Berlusconi was closing the gap.

With a debt mountain of around €2 trillion and the economy barely growing, analysts say Italy needs structural reforms and that the election could determine the pace at which they are implemented.

They worry that if Berlusconi’s alliance wins, Italian debt may spiral out of control, throwing the country back into the deep end of Europe’s debt crisis, just as it was when he resigned in November 2011.

Benchmark Italian bond yields have nearly halved and shares have gained 17 per cent since Berlusconi was replaced by technocrat Mario Monti, helped by European Central Bank President Mario Draghi’s pledge to buy the bonds of indebted eurozone states that request help.

While Monti’s reform agenda and austerity policies improved the confidence of investors and eurozone governments in Italy’s public finances, a return to power for Berlusconi could change that.

Martin Harvey, fund manager at Threadneedle Investments, said if Berlusconi were to win he might sell some of his Italian bonds, which currently account for 16 per cent of his funds, more than the funds’ benchmark index.

“It looks like the alliance involving Berlusconi will not have enough votes to gain power,” he said. “If nearer the time it appears that there may be a less favourable outcome for the markets, we would have to consider reducing our position.”

After pocketing returns of 20 per cent on Italian bonds last year, a level surpassed only by bailed-out Greece, Portugal and Ireland, yield-hungry investors remain positioned for what many of them consider the most favourable outcome – a win by a coalition of centre-left parties led by Pier Luigi Bersani.

“You can’t get the yields you need (in other markets), and there’s certainly an elevated level of pressure to be invested in Italy,” said David Schnautz, interest rate strategist at Commerzbank in New York.

Bersani won investors’ confidence by pledging to stick to the austerity programme prescribed by Monti.

Italy’s borrowing costs hover near lows not seen since 2010, and Milan’s main share index, the FTSE MIB, trades at a 17-month high, showing investors remain confident that the elections will not blow the country off the path of reform.

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