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UPDATE 2-Madrid moves towards direct rule over Catalonia as deadline passes

* Spain had demanded 'yes or no' reply on independence

* Deadline for Catalan leader to give reply was Monday

* Justice minister says Catalan response not valid

* Leader Puigdemont has until Thursday to change mind

* Ambiguity paves way for Madrid to take over region (Recasts with justice minister statement, market reaction)

MADRID/BARCELONA, Oct 16 (Reuters) - Spain's government set the clock ticking on Monday on imposing direct rule over Catalonia, after the region's leader missed a deadline to clarify whether he had declared independence.

The wealthy region threatened to break away following a referendum in Oct. 1 that Spain's Constitutional Court said was illegal. That plunged the country into its worst political crisis since an attempted military coup in 1981.

Catalan leader Carles Puigdemont made a symbolic declaration of independence last Tuesday, but suspended it seconds later and called for negotiations with Madrid on the region's future.

Madrid had given Puigdemont until Monday 10:00 a.m. (0800 GMT) to clarify his position on independence with a "Yes" or "No", and until Thursday to change his mind if he insisted on a split - saying Madrid would suspend Catalonia's autonomy if he chose secession.

Justice Minister Rafael Catala said on Monday the answer that Puigdemont had given in a letter to Spanish Prime Minister Mariano Rajoy was not valid.

"The question was clear but the answer is not," Catala told journalists.

While the government had not yet taken a decision and was still analysing the letter, it would take steps once the Thursday deadline has expired.

Spain's Deputy Prime Minister Soraya Saenz de Santamaria is due to make a statement at 10:30 a.m. (0830 GMT)

Spanish bonds and stocks sold off on Monday after Puigdemont's letter was made public, sweeping away calm generated last week by soothing messages on stimulus from the ECB.

'SINCERE' OFFER OF DIALOGUE

In his letter, Puigdemont did not directly answer the independence question.

The Catalan leader said instead that the two men should meet as soon as possible to open a dialogue over the next two months.

"Our offer for dialogue is sincere and honest. During the next two months, our main objective is to have this dialogue and that all international, Spanish and Catalan institutions and personalities that have expressed the willingness to open a way for dialogue can explore it," Puigdemont said in the letter.

"This way, we will verify the commitment of each of the parties to find an agreed solution."

A declaration of independence would trigger Article 155 of the 1978 constitution, under which the government in Madrid can impose direct rule on any of Spain's 17 autonomous communities if they break the law.

The central government can then sack the local administration and install a new governing team, take control of the police and finances, and call for a snap election.

The Catalan government says 90 percent of Catalans voted for a breakaway in the referendum.

But most opponents of independence boycotted it, reducing turnout to around 43 percent.

Catalan police chief Josep Lluis Trapero was due to appear before Spain's High Court on Monday to be questioned over whether his force, the Mossos d'Esquadra, deliberately failed to enforce the court ban on the independence referendum.

Trapero has been put under formal investigation for sedition after failing to order to rescue Civil Guard police who were trapped inside a Catalan government building in Barcelona by tens of thousands of pro-independence protesters.

The heads of civic groups Asamblea Nacional Catalana and Omnium will also testify over their role in organising those protests. (Additional reporting by Raquel Castillo; Editing by Catherine Evans)