Italian share prices fell and borrowing costs rose on Monday as the recession-hit country braced for a showdown between Prime Minister Enrico Letta and billionaire tycoon Silvio Berlusconi.
Stocks were down 1.58 percent in afternoon trading, while the rate of return demanded by investors on 10-year government bonds were up at 4.520 percent from 4.416 percent on Friday.
"The Berlusconi effect strikes again and there is alarm on the markets," the Italian financial news website firstonline.info said in a commentary.
After weeks of bickering, Berlusconi on Saturday said he was pulling his party's five ministers out of a fragile coalition government with the left and called for early elections as soon as possible.
Letta, a moderate leftist who only came to power this year and has struggled to boost a flagging economy, accused the three-time former prime minister of a "crazy and irresponsible" act.
The 47-year-old Letta has warned against elections at a sensitive time for Italy on the financial markets and just as the economy was hoping to shake off two years of a devastating recession.
He is hoping that members of Berlusconi's party will rebel against their 77-year-old leader by staying in government and voting to support it in a parliamentary confidence vote on Wednesday.
Party leaders in parliament were meeting on Monday for talks in which the rifts within Berlusconi's ranks could become more evident.
Berlusconi will also meet with top members of his party for a meeting expected at 1500 GMT in an attempt to rally support behind his move.
"We want Italy to have a stable government and we start from the principle that the forces at work to stabilise the situation will find a solution," German Chancellor Angela Merkel's spokesman Steffen Seibert told reporters in Berlin.
'We will win' snap polls: Berlusconi
Analysts also played down the prospect of an imminent collapse of the government.
"We have to recognise that the risk of early elections is not insignificant but we think Berlusconi's gamble will not work in the end," said Matteo Cominetta, an analyst for HSBC bank.
London-based consultancy Capital Economics said: "Berlusconi’s decision to withdraw his support for the coalition government may not trigger elections. But the fragile political situation highlights the huge challenges that Italy faces."
Fitch Ratings agency said the instability put Italy's fiscal policy targets at risk and "creates uncertainty at a crucial period when the 2014 budget should be finalised".
The outgoing ministers, while toeing the party line by resigning, have tried to distance themselves from Berlusconi, who has dominated Italian politics for much of the past 20 years.
"How long will the blind and absolute obedience to the leader last this time? Berlusconi's world has never been in such disagreement with Berlusconi," the La Stampa daily said in an editorial.
Berlusconi warns of 'traitors'
One possible scenario is that Letta's government could limp on -- either in its current form or following a reshuffle -- with support from Berlusconi rebels and breakaway members of the anti-establishment Five Star Movement.
Berlusconi has warned his supporters against turning into "traitors", saying: "I do not believe in some little government made up of transfers."
Letta has said the justification used by Berlusconi for withdrawing support for the government -- failure by the cabinet to stop a planned hike in VAT sales tax to 22 percent this week -- was a smokescreen for his own interests.
Tensions have come to a head after the supreme court on August 1 handed Berlusconi his first-ever definitive criminal conviction for tax fraud in a long history of legal woes and sex scandals.
Berlusconi now faces expulsion from parliament and a ban from running in the next elections under a new law aimed at cleaning up Italian politics.
Berlusconi is also appealing other convictions for having sex with an underage 17-year-old prostitute and for abuse of office when he was prime minister.
President Giorgio Napolitano, who plays a crucial steering role during Italy's frequent political crises, has said he will call elections only as a last resort.
Letta's coalition was forged by Napolitano only after a two-month deadlock between the prime minister's centre-left Democratic Party, which won the vote by a razor-thin margin, and its eternal rival, Berlusconi's People of Freedom party.