UPDATE 2-Berlusconi faces revolt over Italy confidence vote
* Berlusconi party secretary calls on group to back government
* Letta assessing support before calling confidence vote
* Financial markets, international partners watching closely
* PDL source says about 30 PDL senators willing to support Letta
ROME, Oct 1 (Reuters) - Senior party figures in Silvio Berlusconi's fractious centre-right movement urged Italian lawmakers on Tuesday to defy the billionaire media tycoon and back Prime Minister Enrico Letta in a confidence motion expected on Wednesday.
Berlusconi's People of Freedom (PDL) party has come close to breaking apart after he pulled his ministers out of the ruling coalition at the weekend and called for new elections following growing tension over his conviction for tax fraud.
Divisions between hardline "hawks" and more moderate "doves" have widened sharply as opposition has grown to Berlusconi's call to bring down Letta's coalition, five months after it was formed in the wake of deadlocked elections in February.
Italy, the euro zone's third-largest economy, has been in political turmoil for the past week, and even if Letta's government survives the vote, there is no certainty that his administration will be strong enough to enact effective reforms to confront its longest postwar recession.
However, the breakdown of unity in Berlusconi's party is a watershed moment for the man who has been the undisputed leader of Italy's centre right for two decades and opens an unpredictable new chapter in Italian politics.
Party secretary and Interior Minister Angelino Alfano and Transport Minister Maurizio Lupi, who handed in their resignations on Berlusconi's orders on Saturday, called on the party to back Letta in the vote expected in the Senate on Wednesday.
"I remain firmly convinced that our entire party should support Letta in a confidence vote," Alfano told reporters.
Letta rejected the resignations of Alfano and Lupi and the three other PDL ministers on Tuesday, a signal that he valued their public backing.
Berlusconi appeared to confirm an impending party split when he decided, after a meeting with his advisers, that he will ask his lawmakers to withdraw their support for Letta on Wednesday, Alessandro Sallusti, editor-in-chief of the party newspaper, said on RAI state TV.
Sources in Letta's centre-left Democratic Party said he had not yet decided whether to call a formal vote of confidence in parliament on Wednesday and was waiting to see what emerged from a frantic round of meetings on Tuesday.
If it does not appear that he has enough support from PDL rebels, he would hand in his resignation to President Giorgio Napolitano before a confidence vote. He could then be re-appointed to try to form a new coalition in parliament, setting off a new round of negotiations.
Letta's Democratic Party (PD) has a strong majority in the lower house, but in the Senate he would need to win support from the PDL or others such as the anti-establishment 5-Star Movement, which has said it will vote against the government.
The parliamentary arithmetic is complicated and deceptive, but to be sure of winning, Letta, who can count on 138 votes from the PD and centrist parties, would need at least 20 more votes for a majority in the 315 seat Senate.
About 30 PDL senators are willing to continue supporting Letta, one PDL source said.
However, the premier has made it clear that scraping through a confidence motion with a handful of votes will not be enough to be able to implement reforms and control public finances.
PDL moderates have called for a new direction in the centre-right and the removal of the ultra-hardliners who have gained increasing influence over Berlusconi in recent weeks.
But it is not clear whether Berlusconi, a billionaire media tycoon who has dominated the centre-right for 20 years, will be able to persuade potential rebels to return or whether the breakdown in his party is final.
IMPACT "FELT THROUGHOUT EUROPE"
As the countdown to the vote began, official figures showed youth unemployment had hit a record of 40.1 percent in August, underlining the dire state of the Italian economy, now in its second year of recession.
President Giorgio Napolitano said in a statement that Letta would seek backing for a "stable commitment for continuing government action from the most immediate deadlines to objectives to be pursued in 2014".
Even if Letta survives a confidence vote, he may not have enough support to pass the kind of deep reforms or painful tax and budget measures needed to reverse a decade of economic stagnation and cut its 2 trillion euro public debt.
But with memories still fresh of the chaos that brought the eurozone to the brink of collapse when the last Berlusconi government fell in 2011, the turmoil in Italy has been closely watched by Rome's international partners.
"The impact of what happens in Italy does not end at the country's borders. It is felt throughout Europe," European Monetary Affairs Commissioner Olli Rehn told reporters in Paris.
Financial markets have also watched closely, and Italy's borrowing costs have risen markedly, though with the European Central Bank pledging to support euro zone bonds, there has been no sign of the panic seen at earlier crisis points.
The main barometer of market concern, the premium investors demand to hold Italian 10-year government bonds over AAA-rated German Bunds has actually fallen from more than 300 basis points at the start of the week to 266 points on Tuesday.
"In the end if Letta is able to get a short-term agreement, if he is able to postpone elections for a few months, then that is a positive result for him and there would be a positive reaction by the markets," said Leonardo Morlino, professor of political science at LUISS University in Rome.
Letta's unwieldy coalition of left and right has struggled ever since it was formed in the wake of last February's deadlocked elections, which left no party able to govern alone.
With Italy's complicated voting system widely expected to produce another stalemate if snap elections were held now, Napolitano has repeatedly said he does not want to dissolve parliament and call a new ballot.
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