UPDATE 2-Berlusconi faces obstacles in bid to topple government
* Markets recover slightly on hopes Letta can survive
* But stability, reform prospects damaged
* Fitch warns political turmoil could lead to ratings cut
* Question mark hangs over future of centre-right
ROME, Sept 30 (Reuters) - Silvio Berlusconi on Monday faced dissent within his People of Freedom Party, complicating his plans to bring down Prime Minister Enrico Letta's coalition government.
But even if Letta survives a confidence vote on Wednesday the prospects for stability and reform in Italy look more fragile than ever as he will face a larger and stronger opposition backed by Berlusconi's media empire.
Letta's hopes of survival appear to rest on some 20 senators from Berlusconi's party, who are unhappy with his shock decision on Saturday to withdraw his ministers from Letta's government.
Italian shares and bonds recovered some of their losses on financial markets after a party source told Reuters the group of PDL moderates may be ready to back the government and break away from the PDL if Berlusconi does not soften his stance.
However, whether the dissidents are actually prepared to back Letta remains to be seen. They did not speak out at a PDL meeting on Monday where Berlusconi called for unity, repeated that the party must push for early elections and did not open any internal debate, according to lawmakers present.
"I asked for a debate and some explanation and I was told politely that it would wait for another occasion," PDL moderate lawmaker Fabrizio Cicchitto, one of the first to express any opposition to Berlusconi, told reporters after the meeting.
In the past those on the centre-right who have dared to stand up to Berlusconi have been quickly despatched to the political wilderness, but the media tycoon's legal problems have opened the possibility of a break-up of the party that has dominated Italian politics for the last 20 years.
Berlusconi's decision to order the five ministers to resign 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.
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 manoeuvring 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.
German Chancellor Angela Merkel called Letta to say she hoped Italy could restore political stability and continue with reforms as euro zone leaders feared the turmoil could unleash broader market upheaval.
If Letta manages to win Wednesday's vote he will be left with a narrow parliamentary majority and face a larger and more aggressive opposition that can count on all the firepower of Berlusconi's considerable media empire.
Few analysts expect that such a government would be able to last past next spring or pass the kind of wide-ranging reforms needed to make the euro zone's most sluggish economy more competitive.
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.
Financial markets, which have been increasingly nervous about Italy after a week of rising political tensions, sold off government bonds and stocks on Monday, though 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 hopes that Berlusconi might back down.
Berlusconi said at the weekend he wanted 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.