By Lisa Jucca and Francesca Landini
MILAN (Reuters) - Investors welcomed on Monday the formation of a new government in Italy, piling into the country's assets and brushing off a warning it might still need international aid to weather a deep economic crisis.
Sovereign borrowing costs fell to their lowest since October 2010 at a sale of 6 billion euros of five-year and 10-year bonds, and blue chip shares rose 1.6 percent - outperforming other European markets.
That suggested approval for the choice of center-left politician Enrico Letta as prime minister, and confidence in his ability to bridge differences with the center-right party of Silvio Berlusconi and the centrists of ex-premier Mario Monti.
Letta's appointment at the weekend at the head of a coalition government ended two months of political deadlock and fuelled hopes about short-term action to tackle the crisis.
But rating agency Moody's warned the economic and political backdrop remained complex and Italy, in its second year of recession and struggling with 2 trillion euros of debt, may still need to seek a bailout.
"We will have to verify the commitment of the new government" to structural reforms, Dietmar Hornung, senior credit officer at Moody's, told newspaper La Repubblica.
"For now the situation remains difficult," said Hornung,
Bankers and businessmen praised the choice as economy minister of Bank of Italy Deputy Governor Fabrizio Saccomanni, a respected economist who should reassure investors that Italy will not stray from fiscal orthodoxy.
"It's clearly an authoritative government. Letta is competent and has experience," said Andrea Cuturi, Vice Chairman of asset manager Anthilia Capital Partners. "The key issue is however how long will this government last and what will it be able to do. This will become clearer in the coming weeks."
The FTSE MIB share index was led by strong gains among Italian banks and in Berlusconi's broadcaster Mediaset.
BTP bond futures were up a hefty 77 ticks and the 10-year bond yield fell below 4 percent at auction.
Italian 10-year borrowing costs peaked at around 7 percent in November 2011, when Mario Monti was sworn in and Italy faced its toughest moment to date during the euro zone crisis.
The yield spread between 10-year Italian bonds and their German equivalent, a closely-watched indicator of sentiment, tightened to 274 basis points from 286 basis points on Friday.
An inconclusive general election at the end of February left Italy, the euro zone's third-largest economy, at the mercy of three litigious main political forces, threatening investor confidence and holding up efforts to end a prolonged recession.
If the new government wins a confidence vote in parliament later on Monday, this would remove the threat of a snap election, an option disliked by investors as it would lead to more uncertainty while a social crisis deepens.
"The fact that we have a government and it is backed by political forces is already a good thing," said Giovanni Bossi, chief executive of Italian bank Banca Ifis.
"The risk is however that it will have to fight forces that are opposing the deal between the center-left and the center-right. It needs to act fast."
The anti-establishment 5-Star Movement has refused to join a government which party leader Beppe Grillo said "bordered on incestuous".
(Additional reporting by Danilo Masoni and Blaise Robinson; Editing by John Stonestreet)