By Amanda Cooper and Jesús Aguado
LONDON/MADRID (Reuters) -Spanish blue-chip shares dropped on Monday after a snap general election at the weekend yielded no clear winner, with investors punishing banks and utilities in particular.
Spain faced political gridlock on Monday after right-wing parties failed to clinch a decisive victory and no clear winner emerged in Sunday's national election.
Madrid's IBEX 35 equity benchmark index fell as much as 1.8% in early trading and was last down 0.7%. It was underperforming the broader STOXX 600, which was flat.
The centre-right People's Party (PP) and the far-right Vox won a combined 169 seats in parliament, while the ruling Socialists (PSOE) and far-left Sumar won 153, well short of the 176 seats needed for a majority.
"The generalised falls are due to the fact that the market is expecting either a weak government or an election ahead," said Natalia Aguirre, head of analysis at Renta 4.
"Now a period of uncertainty is opening up, which is the worst possible scenario for the markets."
The outcome could ultimately lead to the extension of a windfall levy on the financial and energy sector beyond the current two-year period. PP head Alberto Nunez Feijoo had vowed to amend the taxes if he won power.
Shares in major lenders Santander (BME:SAN), Sabadell and Caixabank were down between 1.4% and 2.6%. The Stoxx 600 banks index was 0.4% lower.
Goldman Sachs (NYSE:GS) said on Monday the outcome of the election may also be a temporary setback for Spanish utilities, after the market had recently turned more positive for Endesa and Iberdrola (BME:IBE) on account of "a potential change in government, and prospects for reduced regulatory intervention".
Endesa dropped 3.5% while Iberdrola fell 0.4%.
City Index strategist Fiona Cincotta said: "I don't think it's necessarily part of a darker outlook for Spain in the longer term, but just think at the moment, we're seeing that uncertainty and markets hate uncertainty."
Political consultant Eurasia Group said the uncertainty could last months - much as was the case in 2019, when two back-to-back elections were held before a government could be formed.
"For now, repeat elections look like the most likely way out of the deadlock (a 40% probability); if so they would most likely be held in the fourth quarter of this year," Eurasia Group senior analyst for Europe, Federico Santi, said.
The risk premium for Spanish government debt yields compared to benchmark German 10-year bonds widened slightly to around 106 bps.
Spain's economy has held up relatively well but is slowing from a post-pandemic rebound. The government forecasts 2023 growth of 2.1% versus 5.5% last year.
A slowdown means Spain's high debt of more than 100% of GDP and deficit of 4.8% of GDP are in focus, and drawn out talks to form a government could slow fiscal reforms and worsen its finances.
Giles Gale, head of European rates strategy at NatWest (LON:NWG) Markets, said the election was only mildly negative for Spanish government bonds compared to their German peers.
"There are plenty of reasons for resilience," he said. "The strong fundamental story still holds: positive debt dynamics, economic momentum and financial resilience, strong funding progress, and an increase in domestic demand for debt."