Italian stocks erase May gains on prospect of eurosceptic government

MILAN (Reuters) - Italy's top share index fell more than 1.5 percent to its lowest level since the end of April on the prospects that eurosceptic parties could work out a government deal, threatening fiscal discipline in the euro zone's third-largest economy.

The anti-establishment 5-Star Movement and far-right League have made "significant steps" towards forming a government, the two parties said in a statement on Thursday, as Italy looked to end nine weeks of political deadlock.

Following the statement the FTSE MIB index <.FTMIB> accelerated losses and was down 1.6 percent at 23,886 points by 1050 GMT, leaving further behind its highest closing level in nearly 10 years hit on Monday.

"The prospect of having a government of two eurosceptic parties creates uncertainties... Investors may not trust such a government and fear that debt would rise," said IG Markets analyst Vincenzo Longo, referring to plans by the 5-Star to introduce a basic income and the League's promise of a flat tax.

Earlier on Thursday Italian government bond yields jumped to a seven-week high.

"Italy's country risk is growing," Longo said.

In spite of Thursday's drop, the FTSE MIB remains the best performer among top European share indexes, up nearly 10 percent so far this year.

(Reporting by Danilo Masoni; Editing by Gareth Jones)