* Letta wins Senate confidence vote by 235 votes to 70
* Also wins comfortably in lower house of parliament
* Centre-right in disarray after shock Berlusconi turnaround
* Financial markets rise as government survives
By Paolo Biondi
ROME, Oct 2 (Reuters) - Italian Prime Minister Enrico Lettawon a confidence vote in parliament on Wednesday after SilvioBerlusconi, facing revolt in his own centre-right party,backtracked on threats to bring down the government.
As dozens of centre-right senators prepared to defy theirmedia magnate leader and salvage the left-right coalition led byLetta, Berlusconi staged an abrupt U-turn and said he too wouldback the centre-left prime minister, just days after he sparkedthe crisis by pulling his ministers out of Letta's cabinet.
After a sometimes fiery debate in the upper house, in whichhe faced repeated accusations of sowing chaos in a personal bidto stave off expulsion from parliament over a tax fraudconviction, Berlusconi said: "We have decided, not without someinternal strife, to support the government."
Financial markets reacted positively. But the end of thiscrisis, seven months after an inconclusive election, leavesquestion marks over Letta's ability to address deep problems inItaly's economy which are troubling its partners in the euro.
Letta, who had appeared on course for victory with PDL helpeven before the startling turn of events in the chamber, reactedwith visible surprise to Berlusconi's climbdown, laughingslightly and shaking his head in disbelief.
Berlusconi covered his face with his hands after he satdown; in what may be one of his last acts in the Senate beforethe procedure for his removal begins on Friday, the 77-year-oldthen cast his vote for Letta, a prime minister whom he hadaccused a day earlier of lacking credibility.
Later, as he drove away, he was heckled by onlookers.
"What happened today should be shown in a theatre not inparliament," Federico D'Inca, a deputy from the opposition5-Star Movement said during a debate in the lower house, whereLetta won a second confidence vote in the evening.
Backed by his own Democratic Party (PD) and by Berlusconi'sPeople of Freedom (PDL), the prime minister won the Senate voteby 235 to 70. He then won by 435 to 162 in the lower chamber,where the PD holds a strong majority.
President Giorgio Napolitano, an 88-year-old veteran who hasdelayed his own retirement to try and broker a viable compromisethat can steer Italy out of crisis, praised Letta's "firmness"in parliament. "The main thing is the government has stood thetest," he said in a statement. But he warned it against allowinga return to a daily round of aggressive political rhetoric.
Appointed in April after an election in February that gaveno one a clear majority, Letta said he would press on with aprogramme of fiscal measures to keep Italy's badly strainedpublic finances under control and reforms to confront the worstrecession in 60 years.
He also pledged to reform the widely criticised electorallaw which gives the two houses of parliament equal powers andmakes it difficult for any party to win a functioning majority.
However, the surprising nature of his victory leaves aseries of unanswered questions about both the stability of hisgovernment and the future of Italy's centre-right, which cameclose to implosion as the vote neared.
Having begun as a vote of confidence in Letta, the dayturned into a test for Berlusconi, whose previously unchallengedgrip on the conservative side of the political spectrum facedits biggest threat since he took up politics two decades ago.
His declaration for the prime minister capped a day thatveered between high drama and what one centrist politiciancalled farce, as an unprecedented party rebellion persuadedBerlusconi that there was no point in continuing resistance.
"Berlusconi lost, regardless of the fact that he voted forthe government," PD party secretary Guglielmo Epifani said. "Helost above all before the country and Italian public opinion."
Where the climbdown leaves his badly divided party willbecome clearer in the next few days. Dissidents are alreadymaking clear they want to set up a separate moderate group awayfrom the hardliners, who have gained an increasing influenceover Berlusconi since his conviction.
Angelino Alfano, the 42-year-old PDL party secretary who wasonce seen as Berlusconi's heir, broke with his patron and calledon the party to support the Letta government from which hehimself had resigned as interior minister onSaturday.
An opinion poll by the Ipsos institute conducted on Tuesdayshowed 61 percent of PDL voters felt the party should back Lettaand 51 percent that it should pick a new leader to take overfrom Berlusconi and renew the party.
Financial markets, already buoyed by confidence that Italywould avoid uncertain new elections, welcomed the vote. Shareson the Milan bourse rose nearly two percent and yields on10-year government bonds fell to a low for the day of 4.34percent.
As the debate on the confidence motion opened, Letta saidItaly risked being left without a stable government.
"Italy is running a risk that could be fatal, withoutremedy," he told the Senate. "Thwarting this risk, to seize ornot seize the moment, depends on the choices we will make inthis chamber. It depends on a yes, or a no."
However, uncertainty remains over whether the governmentwill be capable of the kind of deep reforms or painful tax andbudget measures needed to reverse a decade of economicstagnation and cut its 2 trillion euro ($2.7 trillion) debt.
- Politics & Government