UPDATE 1-Merkel says EU will hit Russia with economic sanctions if needed
* Merkel speaks in parliament before EU leaders meet
* Signals Russia could be booted out of G8 (Adds quotes, background)
BERLIN, March 20 (Reuters) - European leaders will show they are ready to ramp up punitive measures against Russia, including politically sensitive economic sanctions, at a summit starting on Thursday, Chancellor Angela Merkel told the German parliament.
The German leader, who has in the last few weeks toughened her stance against Russia over its actions in Ukraine and the integration of the Crimea region, also indicated that the Group of Eight economic powers may expel Russia from the exclusive club.
"The EU summit today and tomorrow will make clear that we are ready at any time to introduce phase-3 measures if there is a worsening of the situation," Merkel told the Bundestag lower house.
The EU has imposed travel bans and asset freezes on people deemed responsible for Russia's incursion into the Ukrainian region of Crimea. Escalation would involve broader bans and could then move to wider trade and financial restrictions.
Germany, Europe's biggest economy, has close economic ties with Russia which is its main supplier of gas and some companies are worried they would be hit if economic sanctions go ahead.
Reiterating her view that Russia's taking of Crimea violated international law and served to isolate President Vladimir Putin, Merkel warned of other consequences for Moscow.
The G8 format, which includes Russia, was effectively dead as long as the diplomatic showdown with Moscow continued, she said. Russia has the presidency of the group and is scheduled to hold a summit in Sochi in June.
"As long as there is no political climate for an important format such as the G8, as is the case at the moment, the G8 no longer exists, neither does the summit nor the format as such."
The United States and its G7 allies will gather next week in The Hague without Russia to consider a further response to the Kremlin's moves in Crimea.
Merkel, who still wants a diplomatic solution to the crisis, also questioned whether annual German-Russian government consultations, scheduled to take place in Leipzig next month, could go ahead.
Last week, Merkel, who was brought up in Communist East Germany, warned Moscow that it risked "massive" political and economic damage if it refused to change course.
The government on Wednesday publicly intervened in business dealings with Russia for the first time since the escalation of the crisis by telling defence contractor Rheinmetall to halt delivery of combat simulation gear to Russia.
European Energy Commissioner Guenther Oettinger spelled out some of the sectors further sanctions discussed by EU leaders in Brussels this week could cover.
"We have products that Russia needs - machines, equipment, hardware, software, vehicles," Oettinger told German television, playing down the prospect of sanctions in the energy sector. (Additional reporting by Stephen Brown and Sarah Marsh; Writing by Madeline Chambers; Edting by Noah Barkin)