11/09/2011 08:50 EST | Updated 01/09/2012 05:12 EST

Canadian Dollar Dips On Italy Economic Fears

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TORONTO - The Canadian dollar closed more than a cent lower Wednesday as investors, nervous about the state of Italy's economy, sold off risk and bought into the perceived safe haven of U.S. Treasury bonds.

The loonie fell 1.31 cents to 97.88 cents US after going as low as 97.72 cents US.

Financial markets had reacted positively Tuesday after Prime Minister Silvio Berlusconi won a confidence vote but said he would resign after his government's new austerity budget was passed. There was little confidence that he could implement the tough measures that eurozone officials have demanded if he remained in power.

But pessimism returned to markets with a vengeance Wednesday as Italy's 10-year yield jumped above the seven per cent level amid uncertainty about who will steer the country through its debt crisis. Bond yields in the seven per cent range are considered unsustainable in the long run.

There was also unhappiness about the fact Berlusconi isn't resigning immediately.

"The problem... is that we are now entering a political interlude that is too long, a time frame for an already grumpy market," said Mark Chandler, head of Canada FIC Strategy at RBC Dominion Securities Inc.

"The transitional government dynamic could prove messy in the interim, especially given that elections would unlikely be held before February."

When Greece, Ireland and Portugal saw their 10-year borrowing rates rise above seven per cent, the markets concluded they had to be bailed out.

But Italy is especially scary for markets because, unlike those countries, Italy's debts are deemed too large for the country to be bailed out.

The dollar was also pressured by commodity prices forced lower on demand concerns and the rising U.S. dollar. A stronger greenback usually helps depress prices for oil and metals, which are denominated in dollars, as it makes commodities more expensive for holders of other currencies.

The December crude contact on the New York Mercantile Exchange fell $1.06 to US$95.74 a barrel.

Metals fell back as the December copper contract in New York lost nine cents to US$3.44 a pound.

The December gold contract in New York was off $7.60 to US$1,791.60 an ounce.

Italy's woes had briefly shifted attention away from Greece, where power-sharing talks had been going on for three days. But the talks ended Wednesday, with political leaders failing to name a new prime minister who will take over from George Papandreou.

The latest Greek crisis erupted last week, when Papandreou said he would put a hard-fought €130 billion debt deal to a referendum. His idea horrified European leaders and sparked a rebellion within his own party.

In response, Papandreou withdrew the plan for a popular vote and agreed to stand aside and hand over to an interim government whose main aim will be to secure a vital €8 billion instalment of bailout loans and approve the debt agreement.