UPDATE 1-Berlusconi faces party revolt over Italy political crisis
* As many as 20 senators ready to form breakaway party -source
* Fitch warns political turmoil could lead to ratings cut
* Bonds and share prices fall as uncertainty weighs
ROME, Sept 30 (Reuters) - About 20 Italian centre-right lawmakers may break with leader Silvio Berlusconi if he tries to bring down prime minister Enrico Letta's coalition in a dispute over Berlusconi's fraud conviction, a centre-right party source warned on Monday.
In a move that may give Letta, from the centre-left, a chance to save his government following the resignations of five ministers from Berlusconi's People of Freedom (PDL), some 20 PDL senators will tell the party leader on Monday they may form a breakaway group in the upper house, the source told Reuters.
"If Silvio doesn't agree to take a step back from what the hawks are proposing, we could have a new moderate group by Wednesday," the source said.
The comment slightly revived prices of Italian stocks and bonds, which have suffered from the prospect of new uncertainty and lack of economic reforms as former premier Berlusconi fights an impending expulsion from the Senate following his conviction.
An inconclusive election in February led to the formation of a fragile left-right coalition under Letta two months later.
Berlusconi's decision to order the five ministers to resign on Saturday has plunged Italy into political chaos and left the euro zone's third-largest economy without a fully operational government, prompting warnings that its sovereign debt rating is at risk.
The move also deepened splits between hardline "hawks" and moderate "doves" in Berlusconi's party. A day after they resigned, all five ministers expressed reservations about their move, which came after a week of growing tensions. Other PDL lawmakers have also openly dissented with the resignations.
Centre-right lawmakers will meet Berlusconi at 5 p.m. (1500 GMT0 in what is likely to be a stormy encounter ahead of a confidence vote in parliament on Wednesday where Letta is openly counting on support from PDL dissidents.
The source said the senators were ready to form a new conservative group separate from the centre-right force that Berlusconi, a billionaire media magnate, has dominated ever since he entered politics in 1994.
Letta, who has a commanding lower house majority, needs to secure a majority in the Senate - where the PDL is currently the second-largest party - in order to continue in government.
As the political manoeuvering in Rome gathered pace, Italy came under heavy international pressure with ratings agency Fitch warning that the crisis could trigger a cut in its BBB+ rating if it slowed efforts to rein in the budget deficit.
Letta's government has been teetering on the edge of crisis ever since Italy's top court convicted Berlusconi of tax fraud last month, opening the way for the 77-year-old to be stripped of his seat in the Senate.
A special Senate committee meeting on Friday is expected to vote to open proceedings that could lead to Berlusconi being thrown out of parliament by mid-October and losing his parliamentary immunity from arrest in this and other cases.
With Italy falling behind in its efforts to bring the budget deficit under European Union limits and youth unemployment running at nearly 40 percent, the prolonged wrangling between the parties has blocked efforts to reform the economy, after two years of recession.
In Brussels, the European Commission said it was watching developments closely after the cabinet failed on Friday to pass measures needed to bring Italy's deficit under the European Union cap of three percent of gross domestic product.
"We are following all developments in Italy very closely and out of respect for the internal democratic process in Italy, we are not going to make any comment at this stage," Commission spokeswoman Pia Ahrenkilde Hansen told reporters.
Financial markets, which have been increasingly nervous about Italy after a week of rising political tensions, sold off government bonds and stocks on Monday, although there was no sign of the panic seen during other recent government crises.
The main barometer of broad market sentiment, the difference between yields on Italian 10 year government bonds and triple A rated German Bunds, widened to 294 basis points, the highest in three months, while stocks on the Milan bourse fell 1.7 percent.
The spread narrowed to 285 points on hope that Berlusconi might back down.
Berlusconi said at the weekend he wanted new elections to be held as soon as possible, only months after the deadlocked ballot in February which left no party with the numbers in parliament to govern alone.
But with opinion polls roughly balanced between Letta's centre-left Democratic Party and the PDL, there is no enthusiasm for a return to the polls under the current voting system, which most analysts believe would simply produce more stalemate.