ROME (Reuters) - Italian centre-right leader Silvio Berlusconi pulled his ministers out of the ruling coalition on Saturday, effectively bringing down the government of Prime Minister Enrico Letta and leaving Europe's third-largest economy in chaos.
The announcement, which will likely lead either to new elections or the formation of a new coalition, came a day after Letta challenged Berlusconi's party to support him in a confidence vote in parliament following weeks of tension.
Late on Friday, the cabinet failed to agree vital fiscal measures to bring the budget deficit within European Union limits, leaving the fragile coalition of traditional rivals from the left and right near total breakdown.
Tensions between the two sides had been rising for weeks following moves to expel Berlusconi from parliament after his conviction for tax fraud last month.
"The decision taken by Prime Minister Enrico Letta to freeze government activities ... is a serious violation of the pacts on which this government was formed," Berlusconi said in a statement.
This week PDL lawmakers threatened to walk out of parliament if he is expelled from the Senate over the conviction.
The ministers' resignations will further delay meaningful reforms in Italy, which is struggling with a two-year recession, a 2 trillion euro public debt and youth unemployment of around 40 percent.
The political convulsions have increasingly worried investors, although with the European Central Bank guaranteeing stability in the markets, there has so far been less panic than seen during previous crises.
Italy's borrowing costs hit a three-month high at an auction of 10-year bonds on Friday, while the premium investors demand to hold Italian government debt rather than German paper widened to about 267 basis points from under 250 at the start of the week. (Reporting by Catherine Hornby and Antonella Cinelli; Editing by Sonya Hepinstall)