GLOBAL investors have returned to the edge of their seats as a knife-edge Italian election has raised fears the eurozone debt crisis could resurface.
Australia's share market lost 1 per cent on Tuesday after Italy's election saw disgraced PM Silvio Berlusconi locked in the lead with former comedian Beppe Grillo.
This stoked fears among investors and initially wiped 1.5 per cent from the value of the bourse. Despite staging a fightback through the day the bourse closed 1 per cent lower overall.
The jitters came as the Reserve Bank warned the cash rate could be used to offset the impact of a high Australian dollar.
These comments, and suggestions the RBA could intervene in currency markets if conditions demanded it, drove the dollar down to below US102.5¢.
Robert Rennie, Westpac's chief currency strategist, said Italy's deadlocked election result would rattle financial markets because it heralded a deterioration in European politics.
"The idea that Berlusconi was finished will now need to be rethought," he said.
"Financial markets will now have to take at face value the idea that the protest vote can actually attain an overall majority in some parts of Europe's legislature. This is indeed a worrying development and one that should rattle financial markets for some time to come."
RBS' senior foreign exchange strategist, Greg Gibbs, said it was unclear how the European Central Bank would respond to events in Italy.
"[Italy] may be ungovernable and [the election result] creates a sudden descent back into uncertainty over the future of the economic policy direction in Italy and the willingness of the ECB to . . . support the Italian bond market."
Comments from RBA assistant governor Guy Debelle that Australia's dollar was higher than it ought to be raised the prospect that the Bank could cut rates again.
Mr Debelle said the dollar looked "higher than the state of the domestic economy and the terms of trade would suggest", but this was primarily due to the weak state of some advanced economies and the resulting policies being pursued by the central banks in those countries.
"To date in Australia, we have been able to counter the effects of the higher Australian dollar with lower interest rates," he said.
"[And] we still obviously retain scope to lower interest rates further, should the need arise, including to counterbalance the pressures of an elevated exchange rate."
But Mr Debelle also raised the prospect of using the RBA's foreign exchange reserves to intervene in the currency market if conditions warranted.
He said the bank had intervened in the market on a number of occasions in the past two decades to facilitate an orderly depreciation of the Australian dollar.
"The most recent episode of intervention was in 2008-09 ... [when] there were various bouts of illiquidity as stresses flared in global markets, particularly following the failure of Lehman Brothers," he said.
The other time was in 2001, when the dollar hit an all-time low of US47¢.
Mr Debelle also defended the RBA's actions last year when a foreign customer bought a large amount of Australian dollars and the RBA decided to keep the foreign exchange rather than sell it back to the market.