Kristine Owram, THE CANADIAN PRESS

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TORONTO - It was another disastrous day for investors, and analysts say the political upheaval in Ottawa is only making things worse.

The Toronto stock market saw its worst one-day percentage loss in more than 21 years while the loonie fell more than half a cent against the U.S. greenback Monday.

There are plenty of concerns putting investors in a foul mood these days, including data confirming the U.S. economy has been in recession for a year and plunging oil and metals prices, on which the resource-based Canadian economy relies.

But analysts said there's no doubt political instability is at least partly to blame for the bleak numbers at the close of markets Monday.

"Certainly if I was a foreigner and I saw what's going on in Ottawa, I'd be selling in Canada right now," said John Stephenson, portfolio manager at First Asset Funds Inc., a Toronto-based money manager.

"It makes us look like a banana republic. It really does."

The S&P/TSX composite index plunged 864.41 points or 9.3 per cent to 8,406.21 Monday while the loonie lost 0.53 of a cent to close at 80.31 cents US.

The losses came as the opposition parties signed a deal to form a coalition government led by Liberal Leader Stephane Dion and advised the Governor General they're ready to take over from the Conservatives.

The Liberals and the NDP - backed by the Bloc Quebecois - have reached a deal to form a coalition for at least 18 months, and said they've agreed to a $30-billion stimulus package should they succeed in forming Canada's first coalition government since the First World War.

Eric Lascelles, an economist with TD Securities, said uncertainty about the country's political future, combined with the instability inherent in a coalition government, is making investors nervous.

"If we don't know who the government will be, markets tend to be a little more unsettled and foreign investors in particular are not going to be comfortable investing in a place in which the leadership is unknown," said Lascelles.

The loonie fell more than three quarters of a cent in early trading then recovered, likely on the hopes that a stimulus package would send interest rates higher and make foreign investment in Canada more appealing.

But its later drop suggested currency traders will face more volatility before the political situation is sorted out, said Steve Malyon, a currency strategist at Scotia Capital.

"It's not positive for the currency that we have a potential toppling of a government that was just elected a few weeks ago amid very fraught economic and financial market circumstances, so that's unlikely to boost foreign investors' sentiment towards the currency right now," Malyon said.

Bank of Montreal economist Doug Porter agreed.

"Currencies backed by strong, stable leadership are being rewarded in this tumultuous environment, and Canada has the opposite," Porter said in a note to clients.

Norman Raschkowan, chief investment officer with Mackenzie Investments, said the dollar is reacting directly to the situation in Ottawa, but the reaction has been relatively slight given the scope of the political crisis.

"If we were going through the same sort of problems in our financial sector that the Americans were, I think people would be much more worried because you'd have a political stagnation in the face of a significant crisis," Raschkowan said.

"But because our banks are in relatively decent shape, I think there's less immediate concern."

And Stephenson pointed out the tumult in Ottawa isn't the only development pushing markets and the dollar downwards.

"If you had to put a weighting on it, is the politics significant? Sure, but it's not the majority of it," he said.

"I think it's more the global backdrop with uncertainty in the U.S., bad economic data everywhere and ... commodity prices."

A stimulus package of the size the Liberals and NDP are proposing could have several implications for both financial markets and the dollar.

Lascelles said a stimulus package will be good for the stock market but bad for the bond market, which investors tend to treat as a safe haven in times of economic uncertainty.

Such a package will also lead to deficit spending - something Finance Minister Jim Flaherty is working to avoid - which could lead to rising inflation. However, this isn't necessarily a bad thing in a climate where analysts are talking about the possibility of deflation, or at least drastically slowed inflation.

"To me, inflation is not a huge concern as an economy goes into a sharp correction. I'd put that one on the back-burner," Lascelles said.

Ultimately, Malyon said Canadians are looking for fiscal and economic leadership to emerge from the political crisis in Ottawa.

"Obviously we're seeing a lot of fiscal policies unveiled across the globe to obviate the accumulating downside risks to economic growth," he said.

"I suppose if the new government comes into power and makes this a priority and crafts sensible fiscal policies to help support the economy, then it might not be all that much of a problem for the Canadian dollar, but that remains to be seen."