Italy's Senate approved crucial economic reforms demanded by the European Union on Friday, the first step in paving the way for Premier Silvio Berlusconi to resign as early as this weekend and a transitional government to be formed.

The 156-12 vote took place after respected economist Mario Monti — widely expected to become the interim prime minister — was welcomed with applause in the Senate chamber, where he was officially designated senator for life.

Italy's president bestowed the title on Monti two days earlier to signal to roiling financial markets that he intended to ask the 68-year-old former European commissioner to try to form a transitional government after Berlusconi leaves office.

The reform legislation now passes to the lower Chamber of Deputies, which is expected to vote on it by Saturday. A Cabinet meeting has been scheduled immediately after the vote, leading to speculation that Berlusconi might tender his resignation to Italy's president as early as Saturday night.

While many politicians appeared to be rallying around Monti, divisions remained within Berlusconi's party and among his allies over whether to support him and under what terms.

The prospect of a government headed by the non-partisan Monti calmed markets for a second day, with Italy's 10-year borrowing rate down a further 0.21 of a percentage point to 6.59 per cent. The Milan stock index was up 1.7 per cent.

Markets took a battering this week on fears Italy was heading for a Greek-style economic crisis that would threaten the existence of the entire eurozone and cause a global recession.

Uncertainty had also been fueled by political deadlock in Greece, where party leaders took days to name a new interim prime minister, former banker Lucas Papademos, and Standard & Poor's accidental rating downgrade of France. The agency later retracted the downgrade report, claiming it had been sent by mistake.

By the end of the tumultuous week, European markets were cautiously stable, though any improvements will depend on developments in Rome.

Italy is under intense pressure to prove it has a strategy to deal with its debts, which stand at €1.9 trillion ($2.6 trillion US), or a huge 120 per cent of economic output. It has to rollover a little more than €300 billion of its debts next year alone. But economic growth is weak and the government failed to enact reforms to revive it over the past decade.

With the eurozone and global economies at risk in the event of an Italian default, European governments are pushing Rome to clear up questions over its political leadership quickly.

"We'll see," Berlusconi said Thursday evening when asked by reporters what the prospects were that his splintering People of Freedom party could back a broad coalition government.

Transport Minister Altero Matteoli said Friday he still believed early elections were the best option —despite widespread belief that a months-long electoral campaign was the last thing Italy needs right now.

"I don't believe markets should decide governments," he told Italy's Sky TG24. "In a moment of crisis it should be voters who decide the problems of a country."

But other members of Berlusconi's party have thrown their support behind Monti as have many in the opposition. The Northern League, whose support to Berlusconi has been key over his two decades in public life, remains opposed.

Monti, a former European competition commissioner and current head of Milan's respected Bocconi University, nevertheless received a sustained round of applause when he entered the Senate chamber Friday morning ahead of the reform vote.

"Our warmest and most cordial welcome," Senate president Renato Schifani told Monti after proclaiming him senator for life, an honorific reserved for the handful of Italians who have most contributed to Italian society.

Austerity measures

Italy's austerity package includes:

  • Increase in its value-added tax to 21 per cent from current 20 per cent.
  • Public-sector wage freeze until 2014.
  • A gradual increase, starting in 2014, of the private sector retirement age for women from 60 to 65 by 2026, the same age as men.
  • Increased efforts to combat tax evasion.
  • An energy sector tax.
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While passage of the reform legislation is critical for Italy's political transition, the measures themselves by no means do all that's necessary to rein in debt or spur growth, which the International Monetary Fund projects at 0.6 per cent this year and 0.3 per cent next year.

The EU has already said Italy will need to take additional measures to balance the budget as promised by 2013.

The reforms, which were tacked on as amendments to Italy's budget legislation, call for the sale of state-owned real estate, the privitazation of some municipal public services and raise the retirement age to 67 starting in 2026 and 70 starting in 2050. But significantly, the legislation contains none of the painful labour market reforms, such as making it easier to fire workers, that have been strongly opposed by unions.