Letta wins confidence vote as Berlusconi backs down

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Italy's Prime Minister Enrico Letta has won a vote of confidence by a resounding margin, just days after his government seemed to be teetering on the brink of collapse.

The dramatic turnaround on Wednesday came after former Prime Minister Silvio Berlusconi said he would support Letta after an increasing number of his party members rebelled against the move to pull down the government.

Italian stocks rallied on Wednesday, with the FTSEMIB hitting a two-year high.

The Senate voted 235 to 70 in favor of the Letta government.

Earlier, Letta delivered a strong speech to the Italian Senate on why he should stay in office. He warned lawmakers of a "fatal" risk to the country's political and economic future.

"Italy is now running a risk that could be fatal, overcoming this risk depends on us and on the choices that we make, it depends on a yes or no [vote]," Letta told parliament in a televised address Wednesday morning, insisting that the Italian economy and political stability were his priorities.

Tensions within the coalition government between Letta's center-left "Democratic party" (PD) and Berlusconi's right-wing "People of Liberty" (PdL) party came to a head at the weekend when the ex-prime minister ordered the resignation of five cabinet ministers from the fragile coalition government. In response, Letta called the confidence vote in an attempt to avoid a fresh election only eight months after the last one.

Italian stocks fell at the start of the week at the threat of further political instability.

(Read more: Italy PM Letta faces showdown)

Berlusconi's attempts to break up the coalition were not met with approval in his party. His deputy and party secretary Angelino Alfano said on Tuesday that members of Berlusconi's PdL party should back Letta.

Alfano's apparent defiance of his leader prompted Italian newspaper 'Il Giornale' (run by Berlusconi's brother) to call Alfano a "traitor" on Wednesday. But one market analyst warned that Berlusconi ignored the dissenting voices within his own party at his peril.

"One can only imagine what Berlusconi thought of that, and hopefully Mr Alfano doesn't find a horse's head in his bed, but if enough of Berlusconi's party were to articulate a similar view when voting then the former prime minister could well be left out in the cold," Michael Hewson from CMC Markets said.

(Read more: Italy faces new elections and economic turmoil, analysts warn)

Berlusconi is also under increasing pressure as he faces a Senate vote on Friday on whether to expel him from politics for a tax fraud conviction he received in August.

Though his hardline stance against the government comes partly in response to this possible expulsion, it is also a result of opposition to plans to increase the country's sales tax in 2014.

Despite the youth of the coalition – patched together 8 weeks after inconclusive elections in April -- the sales tax disagreement is merely the latest in a long line of disagreements and delays in the coalition over economic reforms and tax increases.

(Read more: Silvio Berlusconi's 'Greatest'Hits)

In the meantime, Italy's economy continues to suffer from the infighting, with borrowing costs rising and market turmoil following the political uncertainty at the weekend.

Adding insult to injury, on Tuesday Italy's Treasury posted a state sector budget deficit of 15.5 billion euros ($20.9 billion) in September, widening sharply from a 11.4 billion euro shortfall in the same month last year.

- By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt

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