Italian Prime Minister Romano Prodi resigned on Thursday after his centre-left government lost a confidence vote in the Senate, prompting opposition leader Silvio Berlusconi to demand immediate elections.
"Now we must go to vote. We will say what we want to do in the first 100 days of our government," said conservative former prime minister Berlusconi, who has led Prodi in opinion polls.
But President Giorgio Napolitano may first appoint an interim government to reform a messy electoral system, which in 2006 landed Prodi with a tiny Senate majority and an unstable nine-party coalition ranging from Catholics to communists.
Analysts said the demise of the 61st government since World War Two should not hurt economic growth prospects, as Prodi had been too busy surviving politically to carry out deep reforms, but could threaten a recent improvement in public finances.
Many Italians hope for electoral reform to cure chronic instability, illustrated by the fact that Prodi's 20-month spell in power was the seventh longest government in post-war Italy.
"This isn't necessarily bad news, it all depends what comes after Prodi," said Unicredit MIB economist Marco Valli. "Markets don't like uncertainty but if what follows Prodi is a stronger government, then that could be positive."
Berlusconi's senators opened champagne to celebrate, earning a rebuke from Senate President Franco Marini who said: "Get rid of that bottle, we're not in a pub here." Rome taxi drivers who support him honked their horns and shouted: "We've done it!"
Prodi, 68, was undermined by his own allies, just as when his first spell in office was cut short in 1998. This time a small Catholic party's defection erased his tiny majority in the Senate and made a vote of no confidence almost inevitable.
Napolitano will begin consulting party and parliamentary leaders and former heads of state on Friday to see whether he can muster support for an interim government, to be run by a senior political figure or a technocrat.
The softly spoken former European Commission president, known as the "Professor", had warned senators Italy "cannot afford a power vacuum" when the world economy is slowing down.
In a rowdy debate, where one senator spat at another who was then carried out of the chamber on a stretcher, even the support of unelected lifetime senators could not save Prodi, who lost by 156 votes to 161.
Even one of Prodi's most acerbic critics, Senator Roberto Calderoli of the far-right Northern League, said he admired his pluck: "He will lose the confidence vote but he will fall with a soldier's honour for having fought to the end."
Media magnate Berlusconi, who twice lost elections to Prodi in 1996 and 2006, hopes Napolitano will call quick elections which, according to opinion polls, he would win by a clear margin.
But there is a groundswell of pressure for a reform of election rules first, supported by Napolitano and Prodi.
Prodi can take credit for starting to tidy up the public finances of the euro zone's third largest economy. But the European Union fears Italy's finances may worsen in 2008 and that the budget will still not be balanced by 2011 as promised.
Italian growth forecasts are being cut, industrial output is falling and consumer confidence at its lowest in two-and-a-half years.
Analyst Tito Boeri said that while Berlusconi is Italy's richest man, he may not be the best option for the economy. Prodi's record fighting tax evasion meant "his management of public finances was better than ... under Berlusconi," he said.