Political upheaval seen pushing Italy to centre of euro crisis
* PM Monti to resign after 2013 budget law voted
* Italy general elections now likely in February
* Berlusconi to run as centre-right candidate
By Silvia Aloisi
MILAN, Dec 9 (Reuters) - Prospects of a political crisis in Italy sooner than expected - after Prime Minister Mario Monti said he intends to resign early - are expected to drive up Rome's borrowing costs and tensions in the euro zone after months of calm on the bond market.
Monti's surprise announcement on Saturday that he intended to resign after the approval of next year's budget raised the prospect of an election in February, weeks before the end of his term in April, and heightened the uncertainty over who will succeed him.
Bankers and analysts say the biggest political risk is that former Prime Minister Silvio Berlusconi could tap into growing disenchantment with the structural reforms championed by Monti to make a comeback.
"The key concern among investors is not the early elections but the outcome of such an electoral contest," said Wolfango Piccoli, head of Europe practice at global political risk research firm Eurasia Group.
"A fragmented parliament is likely to emerge, leading to the creation of a patched-up coalition government whose ability to push ahead with the required structural reforms will be severely limited," he added.
Berlusconi, whose withdrawal of support for the government last week triggered the crisis, has already announced he will run on a platform attacking Monti's austerity measures, which he accused of plunging Italy into a recessive spiral.
"Markets will certainly not like Berlusconi's latest move," a senior Italian banker said on condition of anonymity. "A Berlusconi comeback would be a disaster for Italy's finances and for the real economy."
Berlusconi's centre-right PDL party lags the centre-left PD by at least 16 percentage points in opinion polls and also trails the anti-establishment 5-Star Movement led by comedian Beppe Grillo, which has won popularity by banking on public anger against the mainstream political class.
But the media tycoon has in the past confounded pollsters and is likely to use an anti-euro, populist rhetoric to win back support and make it harder for the centre-left to win a clear majority.
Even before Monti's resignation announcement, the government's stand-off with the PDL pushed the premium that investors demand for Italian 10-year bonds on Friday to 323 basis points over equivalent German Bunds. That is still well off a peak of 553 points at the height of the crisis last year.
Another senior Italian banker said he expected the spread to shoot up by 80 to 150 basis points on Monday on 10-year Italian versus German bonds.
If spreads were to rise back to the peak level seen last year, Italy would have to pay an estimated 45 billion euros ($58 billion) of additional interest on its 2 trillion euro public debt, not to mention the higher cost of financing for companies and lenders, bankers say.
"Italy needs a comeback from Berlusconi like it needs a hole in the head," said Nicholas Spiro of Spiro Sovereign Strategy. "The biggest domestic threat to Italy right now is populism."
Analysts said markets, where sentiment has been boosted in recent months by the European Central Bank's pledge to buy bonds of weaker euro zone countries, had assumed that a post-Monti government would continue with his economic policies.
But they said that should not be taken for granted.
Even if centre-left leader Pierluigi Bersani wins the elections as expected, he may not have a strong enough majority to push through the kind of unpopular reforms Italy needs.
Ratings agency Standard & Poor's warned of significant risk that Italy's recession-hit economy would not recover in the second half of 2013 and said there was uncertainty around whether the next government coalition would remain committed to the structural reform agenda pursued by Monti.
While Italy, the euro zone's largest sovereign debtor, is within spitting distance of meeting its 2012 funding needs, it has around 420 billion euros to refinance next year.
A prolonged rise in its bond yields could trigger fears about the sustainability of its debt and could unravel the improvement in market confidence driven by the ECB bond-buying pledge.
This in turn could drag Spain, which has been dithering over whether to request an EU bailout, back into the mire.
"I suspect Italy will face a repeat of the pressures it faced in late-2011, when yields across its debt maturity range rocketed to unsustainable levels," Raj Badiani of IHS Global Insight said.
He and several Italian senior executives did not rule out that another technocrat government, perhaps led again by Monti, could be formed in the second half of 2013 or that Italy could be forced to request help from the EU.
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