* Berlusconi's centre-right ministers resign
* Manoeuvres start to avoid new elections
* Letta accuses Berlusconi of "huge lie"
By Catherine Hornby and Antonella Cinelli
ROME, Sept 28 (Reuters) - Italian centre-right leader SilvioBerlusconi pulled his ministers out of the cabinet on Saturday,effectively bringing down the government of Prime MinisterEnrico Letta and leaving the euro-zone's third-largest economyin chaos.
Talks will now start to find a parliamentary majority toback a new cabinet and avoid going back to an election justseven months after the last one.
The relentless political jockeying that has defined Letta'sfive-month tenure has already thwarted efforts to push throughimportant reforms Italy needs to emerge from a two-yearrecession, a decade-long economic lethargy, a 2-trillion-europublic debt and youth unemployment of around 40 percent.
The resignations will delay those reforms even further.
"So many measures we were working on now risk being setback," Italian Labour Minister Enrico Giovannini told Rai statetelevision. "On Monday our borrowing costs are going to rise bymany points."
Berlusconi's move comes a day after Letta challenged thecentre-right party to support him in a confidence vote inparliament.
Late on Friday, the cabinet failed to agree vital fiscalmeasures to bring the budget deficit within European Unionlimits, leaving the fragile coalition of traditional rivals fromthe left and right near total breakdown.
Tensions between the two sides had been rising for weeksfollowing moves to expel Berlusconi from parliament after hisconviction for tax fraud last month.
The Friday cabinet meeting had been intended to find fundingto avert an increase in sales tax from 21 percent to 22 percent.That increase, which has been fiercely opposed by Berlusconi'sparty, will now kick in from Tuesday.
"The decision taken by Prime Minister Enrico Letta to freezegovernment activities, and therefore setting off an increase insales tax, is a serious violation of the pacts on which thisgovernment was formed," Berlusconi said in a statement onSaturday.
Letta shot back later in the evening, accusing the formerprime minister of telling a "huge lie" and of using the salestax issue as an alibi for an action motivated by his legalproblems.
Lawmakers from Berlusconi's People of Freedom (PDL) partythis week threatened to walk out of parliament if a Senatecommittee meeting on Oct. 4 voted to begin proceedings to expeltheir leader, who turns 77 on Sunday, under legislation thatbars convicted criminals from parliament.
Some opposition politicians called for early elections, but Deputy Economy Minister Stefano Fassina, from Letta's DemocraticParty, said he expected a new coalition could be formed.
"I don't see elections. We won't go to them, we will find asolution in parliament," Fassina told La7 television. "I am surethere is a majority in parliament able to avoid elections."
Letta has a commanding majority in the lower house, and ifhe can gain support from a few dozen Senators among the PDL oropposition groupings such as the anti-establishment 5-Starmovement, he could form a new government.
Italian President Giorgio Napolitano, who has to either callnew elections or oversee the creation of a new coalition andsubsequent government, gave renewed signals on Saturday that hedid not want the country to return to the polls.
"We need a parliament that discusses and works, not thatbreaks up every now and then," Napolitano said during a visit toNaples.
"We do not need continuous election campaigns, we needcontinuity of the government's actions, decisions and itsmeasures to resolve the problems of this country," he said.
The political convulsions have increasingly worriedinvestors, although with the European Central Bank guaranteeingstability in the markets, there has so far been less panic thanseen during previous crises.
The ECB's next board meeting is on Wednesday.
Italy's borrowing costs hit a three-month high at an auctionof 10-year bonds on Friday, while the premium investors demandto hold Italian government debt rather than German paper widenedto about 267 basis points from under 250 at the start of theweek.
"We are paying for our political instability," LabourMinister Giovannini told Rai.
As of Friday, Italy has raised around 81 percent of itsfunding target of 470 billion euros for the whole year.
- Budget, Tax & Economy
- Politics & Government
- Enrico Letta