|Italian Prime Minister, Silvio Berlusconi leaves the Quirinale Palace after meeting President Giorgio Napolitano on November 8th 2011|
(Reuters) - Italy's Senate is set to vote on Friday on austerity measures demanded by the European Union to avert a euro zone meltdown, after U.S. President Barack Obama ratcheted up pressure for more dramatic action.
Obama spoke with German Chancellor Angela Merkel and French President Nicolas Sarkozy late on Thursday and also called Italian President Giorgio Napolitano. Treasury Secretary Timothy Geithner demanded fast action from Europe.
"The crisis in Europe remains the central challenge to global growth. It is crucial that Europe move quickly to put in place a strong plan to restore financial stability," Geithner said in a statement following a meeting with finance ministers from the Asia Pacific Economic Cooperation countries.
After months of dithering and delay, Rome appears to have got to the message after bond markets pushed it to the brink.
The Italian upper house is due to vote on a package of cuts later in the day. The law should pass easily, as it should in the lower house on Saturday.
Voting for the first time in the upper house will be Mario Monti, the former European Commissioner who has emerged as favorite to replace Silvio Berlusconi as prime minister.
Berlusconi, who lost his majority in a vote on Tuesday, has promised to resign after the financial stability law is passed by both houses of parliament.
If the votes pass smoothly, Napolitano may accept Berlusconi's resignation as early as Saturday night and formally mandate Monti to try to form a new government soon afterwards.
At first, Berlusconi had insisted that early elections were the only option. But he has since softened his stand and is said by sources to be open to a new government.
Markets were calmed at the prospect of an interim government, rather than a three-month vacuum before elections are held.
Monti, a highly respected international figure, has been pushed for weeks as the most suitable figure to lead a national unity government to push through painful austerity measures.
The euro held steady above its recent one-month low but investors were skeptical it would climb far, given that even a technocrat Italian government might struggle to make progress on long-promised, never-delivered fiscal reforms.
Safe haven German Bund futures extended the previous day's losses at the opening on Friday but again trade was cautious.
"Given how far we have widened out in some of these peripherals, we can have maybe two or three days of calm -- in inverted commas -- but nothing has really changed underneath," one bond trader said.
PAPADEMOS IN POWER
In Athens, Greece's prime minister designate was set to name a new crisis cabinet on Friday to calm the political turmoil that has threatened to bankrupt Athens and force it out of the euro zone.
Greece's two main parties agreed on Thursday to make Lucas Papademos head of a new unity government, ending a chaotic search for a leader to save the country from default. He must now fulfill the terms of a 130 billion euro bailout plan agreed with European partners in October.
"The path will not be easy but I am convinced the problems will be resolved faster and at a smaller cost if there is unity, understanding and prudence," Papademos said on Thursday.
He was left working alone in his new prime ministerial office on Thursday night after talks on the new government ended with no sign of an agreement.
Sources in the two parties -- the ruling Socialists and the opposition New Democracy -- said Evangelos Venizelos was likely to remain as finance minister when President Karolos Papoulias swears in the new cabinet, scheduled for 1200 GMT (7 a.m. ET).
With European leaders dithering over how to tackle the deepening crisis, pressure has mounted on the European Central Bank to act more forcefully.
Three senior ECB policymakers on Thursday rebuffed pressure from investors and world leaders to intervene massively as a lender of last resort on bond markets to shield Italy and Spain from financial contagion.
The euro zone's plan for a more powerful rescue fund may also be running into trouble.
Klaus Regling, the head of the 440 billion euro European Financial Stability Facility, was reported by the Financial Times as saying the recent market turmoil had made it more difficult to scale it up to 1 trillion euros, as planned by EU leaders.
Investors have fled from bonds issued by highly indebted countries. Luring them back by offering insurance on losses, the centerpiece of a plan agreed in Brussels on October 26, would now probably use up more of the fund's resources, Regling said.
"The political turmoil that we saw in the last 10 days probably reduces the potential for leverage. It was always ambitious to have that number, but I'm not ruling it out," the FT quoted him as saying.
(Writing by Mike Peacock)