ROME (Reuters) - Silvio Berlusconi's party withdrew its support for Prime Minister Mario Monti on Thursday, raising the risk of a snap election, but President Giorgio Napolitano said he would work to avoid a crisis and there was no need for alarm.
The centre-right People of Freedom (PDL) party walked out of a Senate confidence vote on a package of economic measures on Thursday and said it would abstain in a separate confidence vote in the lower house later in the day after a senior minister criticised Berlusconi.
The PDL bitterly criticised Monti's austerity measures.
The move raised the risk that Monti's technocrat government could fall and an election be called a few weeks earlier than the expected date in early March.
But head of state Napolitano, who makes the final decision on whether to call an election, said there was no need for alarm on international markets and Italy's institutions were strong.
He said a turbulent end to the five-year legislature must be avoided so Monti's government could complete its programme.
International markets are nervous about what will happen after Monti steps down. The respected former European Commissioner has restored confidence in Italy since he took over a year ago from the flamboyant and scandal-plagued Berlusconi.
"There are pre-electoral political tensions that even outside Italy can be understood without creating alarm about the institutional strength of the country," Napolitano said.
Although the PDL moves did not directly threaten the survival of Monti's government, the centre-left Democratic Party (PD) indicated it could ask Napolitano to dissolve parliament if Monti was not sure of the backing of the centre-right PDL.
The conflict underlined the deep uncertainty in Italian politics before next spring's election and weakened bond prices.
The PDL moves seemed prompted by Berlusconi's intention, after months of indecision, to return to centre stage in an increasingly fevered pre-election atmosphere.
He dropped a strong hint late on Wednesday that he could go back on previous statements and run for a fifth term as prime minister in the election.
He said Italy's situation was much worse than when he stepped down and the country was on the edge of an abyss.
In a television interview early on Thursday, Industry Minister Corrado Passera expressed strong reservations about a return by the 76-year-old billionaire, who left office last year as investors despaired of him addressing the country's economic crisis and Italy seemed headed for a Greek-style crisis.
"Anything which can make the rest of the world or our partners imagine that we are turning back is not a good thing for Italy," Passera told state broadcaster RAI.
The premium investors demand to hold Italian 10-year BTP bonds rather than lower-risk German Bunds widened to 330 basis points, having fallen below 300 points earlier in the week.
The stand-off deepens the confusion surrounding the election and threatens to open a severe political crisis in the euro zone's third largest economy.
The government easily won the Senate vote by 127 to 17 votes with 23 abstentions, but the result made it clear that Monti could not rely on a majority.
Monti relies on the support of both the PDL and the PD in parliament, but the alliance has frequently been fractious.
In a statement on Wednesday, Berlusconi accused Monti's government of dragging Italy into an "endless recessive spiral" with its austerity policies.
Passera retorted that most of Italy's deep economic problems were the result of a decade of poor management. Finance Minister Vittorio Grilli also rejected Berlusconi's accusations.
Berlusconi, who was in power for most of the past 10 years, has changed his mind several times over whether to run next year.
He faces deep divisions within the PDL, which is lagging in opinion polls and split between loyalists opposed to Monti and other factions, including many who want to continue backing the government's reform agenda.
Berlusconi's indecision has further undermined the party he founded, whose support is now at less than half the level that won it a landslide election victory in 2008.
Additional reporting by Paolo Biondi, Massimiliano Di Giorgio, Writing by James Mackenzie and Barry Moody.