LONDON (Reuters) - Carlo Cottarelli, the ex-IMF official appointed to form an Italian government after this weekend's showdown between its president and the two parties that won the March election, faces an uphill battle.

Former senior International Monetary Fund official Carlo Cottarelli arrives to talk to the media after a meeting with Italy's President Sergio Mattarella at the Quirinal Palace in Rome, May 28, 2018

Last night was the darkest Italy’s democracy has ever seen. The truth is they don’t want us to take power Luigi Di Maio, leader of Italy's 5-Star

He is almost certain to fail to get backing from parliament because there is no way that lawmakers from the anti-establishment 5-Star and eurosceptic League can back him while remaining true to their principles. Even as a caretaker premier he may find it impossible to pass a budget for next year, in which case new elections could come as early as September.

With some models predicting that 5-Star and League could between them control up to two-thirds of the new parliament, the question is whether they turn the election into a vote on staying in the euro, or merely demand a radical overhaul of its rules.

One way of benchmarking the risk this poses to the single currency is the Euro Breakup Index that survey group sentix has published each month since the final days of the sovereign debt crisis. Its reading this month suggests 13 percent of all surveyed investors expect the euro to break up within the next twelve months, compared to a high of 73 percent in July 2012 and a low of 6.3 percent just a month ago.

A fresh blow has been dealt to British PM Theresa May's suggestion of using technology to overcome the Irish border question after Brexit, with UK manufacturers declaring it unrealistic.

The so-called “max fac” plan in which Britain and the EU would be separate customs areas but would try to use technology to reduce trade delays and costs at the border is one of two proposals current under consideration; like the other one - a new form of customs “partnership” - it had in any case been dismissed out of hand by Brussels.

Now the EEF manufacturers' association has branded it a "non-starter", arguing that despite similar arrangements at the U.S.-Canada border, most goods there were still subject to normal checks. That comes after the EU’s Brexit negotiator Michel Barnier at the weekend urged Britain to stop “playing hide and seek” over what it wants from post-Brexit ties with the EU.

In Hungary, Viktor Orban's government will today submit to parliament an even tougher version of its bill on regulating NGO activities, adding criminal penalties for groups deemed to be financing illegal immigration.

The legislation is part of the nationalist right-wing government’s campaign against George Soros, the Hungarian-born U.S. financier known for funding liberal causes - hence its nickname the “Stop Soros” bill.

MARKETS AT 0655 GMT

Italy’s political and constitutional crisis deepens and financial markets continue to recoil at the prospect of at least another six months of uncertainty about where it will all end up as new elections sometime in October are now expected.

The interim technocrat government appointed by President Mattarella will be headed by former IMF official Cottarelli, but the two parties who tried to form a government – 5-Star and the League are now calling for the impeachment of the President for rejecting their extreme anti-euro pick for economy minister and effectively collapsing the proposed coalition’s chances of power.

Markets now fear the two parties will campaign on a more explicit euro exit ticket in new elections later this year.

The 10-year Italian-German government bond yield premium, which has now doubled in just two weeks, climbed further to 2.55 percentage points early on Tuesday – its highest since October 2013, although still less than half of the 2012 peak hit shortly before European Central Bank chief Draghi’s ‘whatever it takes’ intervention on behalf of the euro.

Italy’s 10-year nominal yield topped 2.90 percent, its highest since 2014, and two-year yields hit 1.93 percent, their highest since 2013.

With markets also nervy about a vote of confidence in Spanish Prime Minister Rajoy on Friday over corruption allegations, the euro was also under the cosh and fell below $1.16 for the first time since November last year. After Italian stocks dropped more than 2 percent on Monday, European stock futures pointed to further losses today – with eyes on Italian bank stocks that shed more than 4 percent on Monday.

The overall mood on world markets was gloomy as a result, amid fears for the damage to European business confidence more widely. Ten-year U.S. Treasury yields fell below 2.90 percent for the first time since mid-April. Asia’s major bourses were down between 0.5-1.0 percent, with losses offset partly by renewed optimism about a U.S.-North Korea summit next month.

Emerging markets remained under pressure, however, with Brazil stocks hit hard by transport strikes and protests that many fear could boost food protests. Turkey’s lira edged back lower after strengthening more than 2 percent on Monday when the central bank moved to simplify its complex interest rate structure to help battle the currency’s plunge this year. Brent crude was steady just above $75 per barrel.

-- A look at the day ahead from European Economics and Politics Editor Mark John and EMEA markets editor Mike Dolan. The views expressed are their own. --