Telecom Italia is Europe's fifth largest telecoms firm

AT&T and Mexico's America Movil had been in exclusive talks about investing in Olimpia - which owns 18% of Telecom Italia - for up to 4.5bn euros ($6bn).

The prospect of one of Italy's largest firms being controlled by foreign interests has worried many politicians.

Prime Minister Romano Prodi has signalled support for an Italian bid.

Investor anger

America Movil, owned by Mexican billionaire Carlos Slim, has until the end of the month to decide whether to proceed with a bid on its own or seek a new partner.

AT&T said it had "appreciated the opportunity to explore a possible investment in Olimpia but has decided not pursue the matter further".

Tyre firm Pirelli, which owns 80% of Olimpia, has been looking to reduce its stake after making significant losses.

Although Olimpia owns just 18% of Telecom Italia, it is the largest shareholder and nominates most of the firm's directors.

Italian bank Intesa Sanpaolo has expressed interest in investing in Olimpia, potentially on its own or as part of a consortium.

Newspaper reports have suggested rival Italian bank Mediobanca is lining up a bid.

Meanwhile, Telecom Italia shareholders criticised its management during a stormy meeting in Milan called to select a new chairman.

Its previous two chairmen quit after rows over strategy and the make-up of the firm's board of directors.