Italian. U.S. politics drag down European shares
* Italy's FTSE MIB down 1.2 pct after ministers resign
* Sentiment also fragile on U.S. budget impasse
* Pan-European FTSEurofirst 300 index falls 0.6 percent
LONDON, Sept 30 (Reuters) - Italian shares hit a three-week low on Monday after ministerial resignations threatened the survival of the government, while political wrangling over the U.S. budget also dented European investor sentiment.
Italy's FTSE MIB fell 1.2 percent to 17,434.86 points after earlier hitting 17,199.82, its lowest since Sept. 10, as ministers from the party of Silvio Berlusconi withdrew from the cabinet over threats to evict him from parliament after a tax fraud conviction.
The index pared losses after about 20 lawmakers from Berlusconi's People of Freedom party (PDL) threatened to form a breakaway group unless the ex-premier backed down.
The Milan bourse is still up 14 percent this quarter, its best performance since 2009.
Investors are nervous, however, as the political turmoil has the potential to upset Italy's economic recovery. Rating agency Fitch said prolonged uncertainty in the heavily indebted country could trigger a cut in its credit rating.
"I would not touch Italy at the moment as the political uncertainty is bringing some fears about the government's stability. I would rather invest in ...Germany and France," said Anthony Chemla, Asset allocation manager at B Capital Wealth Management.
"... (But) if political stability comes back, valuations could be a catalyst for the Italian market."
The FTSEurofirst 300, up more than 8 percent this quarter, closed 0.6 percent lower at 1,247.14 points after dropping to a three-week low of 1,241.78 earlier in the day, with the European volatility index surging 15 percent to a three-week high.
The Italian political crisis soured sentiment at a time when the market was already jittery over the political impasse in the United States that could result in a government shutdown.
If a stop-gap spending bill for the new fiscal year is not passed before midnight on Monday, government agencies and programmes deemed non-essential will begin closing their doors for the first time in 17 years.
Italian stocks accounted for Europe's biggest movers. Intesa Sanpaolo fell 3.5 percent, the top decliner on the FTSEurofirst 300 index, with traders citing the appointment of new CEO Carlo Messia as negative for the stock, potentially signalling more risky merger activity.
Telecom Italia was among a few top Italian stocks to rise, up 5.2 percent after reports its CEO was set to resign, allaying concerns over a possible capital hike, with a JP Morgan upgrade also helping the stock.
Analysts remained positive on the stock market's outlook.
"We believe that there is a strong fundamental case for European equities, driven by improving economic growth, high operational gearing and reasonable valuation," analysts at Goldman Sachs said in a note.
September's global asset allocation poll showed investors boosted euro zone equities for a third month in a row to levels not seen since March 2012, thanks to a brighter economic outlook in the region.