By James Mackenzie

ROME (Reuters) - Allies of Silvio Berlusconi stepped up warnings on Tuesday that they would bring down Italy's unstable ruling coalition if center-left lawmakers refuse to delay a hearing over expelling the billionaire former prime minister from parliament.

A cross-party Senate committee, which is deciding whether Berlusconi should be stripped of his seat in the upper house following a conviction for tax fraud last month, resumes talks at 8.00 p.m. (1800 GMT) after an initial meeting on Monday.

But already tensions have flared, with Francesco Nitto Palma, a senator from Berlusconi's People of Freedom party (PDL), accusing center-left members of the committee of "an act of war" by insisting on moving ahead swiftly with the hearings.

Whether the threats go beyond simple brinkmanship remains unclear but the wrangling around the hearings has underlined how entwined Italy's political stability remains with the personal fate of Berlusconi, 20 years after he first entered politics.

With Italy still straining to contain its 2 trillion euro public debt, the Berlusconi imbroglio has also hobbled Prime Minister Enrico Letta's efforts to reform the euro zone's third largest economy, causing worries that extend well beyond Italy's own borders.

Even before the committee meeting had properly begun, arguments broke out between the main partners in Letta's coalition, with PDL members proposing an immediate delay until an appeal to the European Court of Human Rights can be heard.

They were rebuffed by the center-left Democratic Party (PD), which has the largest number of members on the 23-member committee, and which accused the center-right of delaying tactics which could put off any decision for several months.

Renato Brunetta, floor leader of the PDL in the lower house, said that if the PD and the anti-establishment 5-Star Movement led by comic Beppe Grillo maintained their opposition, the fragile coalition formed in the wake of last February's deadlocked parliamentary elections would fall apart.

"If the Democratic Party and Grillo's people decide this evening to vote against the proposals, the Democratic Party will bring down the Letta government," he told RAI state radio.

Berlusconi, convicted by Italy's top court last month of being at the center of a vast tax fraud conspiracy at his Mediaset television empire, could not be expelled without a full vote on the floor of the upper house.

But he in any case faces banishment from front-line politics for at least a year after the court sentenced him to a four-year jail term that was then commuted to one year under house arrest or in community service.

BANK OF ITALY WARNING

Whether a government crisis would necessarily lead to new elections is unclear, given President Giorgio Napolitano's stated reluctance to send Italy back to the polls less than a year after the inconclusive February election.

If the PDL makes good on its threat, Napolitano could try to oversee the creation of a new government formed around the PD with the support of dissidents from the center-right or Grillo's 5-Star Movement.

With the European Central Bank pledging to step in to prevent bond market turmoil of the kind which threatened Italy at the height of the euro zone debt crisis in 2011, financial markets have shown no signs of panic.

But Italy's borrowing costs have crept up over the past few weeks and an auction of mid-term bonds on Thursday will be closely watched for any signs of investor nerves.

Although there have been faint signs of improvement after some two years of recession, data on Tuesday showed the economy still far from recovery. Gross domestic product contracted by 2.1 percent in the second quarter and cash-strapped Italian consumers continued to cut back on spending.

Bank of Italy Governor Ignazio Visco said the decline in output should end in the next few months but he warned that the any recovery could be at risk from the political instability.

However, despite a chorus of warnings from bodies ranging from the European Commission to the International Monetary Fund that Italy cannot afford political chaos, parliament has been absorbed for weeks in the details of Berlusconi's legal woes.

The center-right maintains that Berlusconi is the victim of leftist magistrates and says the so-called "Severino law" under which he could be expelled from the Senate cannot apply in his case because it was only passed last year, after the events over which he was convicted.

His appeal to the European Court of Human Rights is aimed at having the law declared inapplicable but it would be several months before the court would be ready to reach any decision.

(Editing by Mark Heinrich)

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