Analysis: Italy's Berlusconi risks decisive showdown

ROME (Reuters) - Italian Prime Minister Silvio Berlusconi has taken a calculated gamble in breaking with his estranged former ally Gianfranco Fini and is likely to be taking the country toward an early election.

Supporters of the lower house speaker have formed a breakaway group in parliament but say they will continue to vote with the ruling People of Freedom party so long as it sticks to its electoral program, meaning the government does not face immediate collapse.

Fini said his fellow rebels "will not hesitate to fight proposals that are unfair or damaging to the wider interest," underscoring the power they will have to make life difficult for Berlusconi.

Parliament breaks for its summer recess after next week but there is not expected to be any make-or-break vote that would force new elections.

But further ahead, it is difficult to see Berlusconi continuing to try to continue with the constant threat of parliamentary guerilla warfare or a slimmer majority hanging over his head. "It is going to make governing very difficult," said David Lea, an analyst with consultants Control Risks. "Fini's people are going to know where the soft spots are and they're going to know which rib to punch to hurt the government."

Given that, the 73-year-old premier is likely to try to persuade President Giorgio Napolitano to dissolve parliament and call new elections in the coming months.

Recent opinion polls have shown Berlusconi's approval ratings slumping but they have also shown a weakening in support for most other parties, including the badly divided center-left opposition.

That suggests that Berlusconi may move quickly, taking a bet that a series of corruption scandals that have engulfed his government and forced two ministers and a junior minister to resign in recent months will be forgotten by voters.

ECONOMIC PROBLEMS

Without a quick resolution, a prolonged period of political instability could bring unwelcome attention from twitchy financial markets that so far have been largely satisfied with the government's response to the financial crisis.

Aware of the potential menace from market turmoil, Berlusconi waited until his government's 25-billion-euro ($32.62 billion) austerity package was approved in parliament on Thursday before moving against Fini.

But he never appeared to be a determined advocate of the package, which was driven mainly by Economy Minister Giulio Tremonti, and the prospect of an election could prompt him to loosen the government purse strings.

However, with Italy's public debt amounting to almost 120 percent of gross domestic product, financial markets are likely to be unforgiving to any backsliding on budget discipline.

"If consolidation efforts are delayed or hampered by fiscal slippage, the long- and short-term sovereign ratings could come under downward pressure," Barclays Capital Research analyst Fabio Fois wrote in a research note on Friday.

Beyond the immediate issue of public finance, prolonged political uncertainty, either through parliamentary stalemate or an election campaign could also affect the government's approach to other sensitive economic problems.

The most notable of these is carmaker Fiat SpA's battle to reform working practices at its sprawling domestic plants, a struggle that underlines the long-term challenge of improving the competitiveness of the sluggish Italian economy.

(Editing by Michael Roddy)