U.S. Senate narrowly passes first budget in four years

WASHINGTON, March 23 | Sat Mar 23, 2013 5:16am EDT

WASHINGTON, March 23 (Reuters) - The U.S. Senate on Saturday narrowly passed its first federal budget in four years, a move that will usher in a relative lull in Washington's fiscal wars until an anticipated summer showdown over raising the debt ceiling.

The Senate budget plan passed on a 50-49 vote in the Democratic-controlled chamber. Four Democratic senators facing re-election in 2014 joined all Senate Republicans in opposing the measure, which seeks to raise nearly $1 trillion in new tax revenues by closing some tax breaks for the wealthy.

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WRAPUP 2-Cyprus bailout bid goes down to the wire

Sat Mar 23, 2013 5:32am EDT

* Euro zone finance ministers schedule Sunday meeting

* Cypriot parliament to debate bank levy after Brussels talks

* Russia rebuffs Cypriot entreaties for aid

* Cyprus eyes levy on bank deposits over 100,000 euros

By Michele Kambas and Karolina Tagaris

NICOSIA, March 23 (Reuters) - Cyprus's bid to avert financial collapse will go down to the wire after the island said it would hold a crucial sitting of parliament only after finance ministers of the 17-nation euro zone meet on Sunday.

Cyprus faces a Monday deadline to clinch a 10 billion euro ($13 billion) bailout from the European Union or the European Central Bank sauys it will cut off emergency funding to the country's stricken banks, spelling certain collapse and potentially pushing the island out of Europe's single currency.

Lawmakers are expected to debate a possible levy on big depositors in Cypriot banks to help secure the 5.8 billion euros demanded by the European Union before it gives the nod to the bailout.

But with euro zone finance ministers due to meet on Sunday afternoon, a senior lawmaker in Nicosia told Reuters the island's tiny legislature would wait until after the Brussels meeting to hold its debate.

"We will meet after the Eurogroup meeting," the lawmaker, speaking on condition of anonymity, told Reuters. "I don't know when."

A government official, who also declined to be named, said Cypriot officials were to hold talks with representatives from the so-called 'troika' of lenders - the EU, ECB and International Monetary Fund - on Saturday morning.

The official said President Nicos Anastasiades, barely a month in office and wrestling with Cyprus's worst crisis since an invasion by Turkish forces in 1974 split the country in two, may head to Brussels on Saturday depending on the outcome of the troika talks, though formal meetings are not expected until Sunday.

Racing to placate its European partners, Cypriot lawmakers voted in a late-night session on Friday to nationalise state pensions and split failing lenders into good and bad banks. They also gave the government powers to impose capital controls on banks, anticipating a flood of money from the island when banks are due to reopen on Tuesday after more than a week of lockdown.

PLUS-20 PCT LEVY?

Signalling a dramatic U-turn, officials said they were near agreement to tax deposits of over 100,000 euros in at least one Cypriot bank, having angrily rejected a similar measure on Tuesday branding it "bank robbery".

The turnaround came after Russia rebuffed Cypriot entreaties to help its banks, where Russian citizens and other foreigners have billions of euros at stake.

Cypriots were enraged by plans to hit small holdings of ordinary savers as well as large accounts.

Many of the biggest depositors are foreigners, including rich Russians, and European politicians are loathe to spend taxpayers' money on a bailout if the depositors take no losses.

Cypriot leaders, however, fear the damage the levy would do to the country's offshore banking industry. The tottering banks hold 68 billion euros in deposits, including 38 billion in accounts of more than 100,000 euros - enormous sums for an island of 1.1 million people which could never sustain such a big financial system on its own.

Much of the banks' capital was wiped out by investments in Greece, the epicentre of the euro zone debt crisis.

Party officials told Reuters that discussions were now centred on a 20 percent-plus levy on depositors holding over 100,000 euros, possibly only at the island's biggest lender, Bank of Cyprus.

The plan to nationalise semi-state pension funds has, however, met with resistance, particularly from Germany which made clear that tapping pensions could by even more painful for ordinary Cypriots than a deposit levy.

"EDGE OF AN ABYSS"

Taking a first step toward financial consolidation, Cyprus arranged on Friday for the takeover of big Greek units of its two biggest banks by a Greek competitor.

Lawmakers then gave the government the power to potentially split the good and bad assets of Bank of Cyprus and No. 2 lender Cyprus Popular Bank, also known as Laiki, and to protect deposits that enjoy a state guarantee of up to 100,000 euros.

"With the process of consolidation, the depositors over 100,000 euros will wait for several years to see how much of their deposits they will collect," said Averof Neophytou, deputy leader of the ruling Democratic Rally party.

"At the same time, this political decision to support this harsh law safeguards 100 percent of the deposits of 361,000 depositors in Laiki Bank," he added, referring to depositors with up to 100,000 euros.

The pace of the unfolding drama has stunned Cypriots, who have besieged bank cash machines since the levy was first mooted a week ago.

"Our so-called friends and partners sold us out," said Marios Panayides, 65, a protester at the parliament. "They have completely abandoned us on the edge of an abyss."

Retailers, facing cash-on-delivery demands from suppliers, warned stocks were running low.

"At the moment, supplies will last another two or three days," said Adamos Hadijadamou, head of Cyprus's Association of Supermarkets. "We'll have a problem if this is not resolved by next week."

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UPDATE 2-U.S. Senate narrowly passes first budget in four years

Sat Mar 23, 2013 6:18am EDT

* Four Democrats oppose their party's budget in 50-49 vote

* Passage of Senate plan shifts fiscal debate away from deadlines

* Possible fight over U.S. debt ceiling looms in summer

By David Lawder

WASHINGTON, March 23 (Reuters) - The U.S. Senate on Saturday narrowly passed its first federal budget in four years, a move that will usher in a relative lull in Washington's fiscal wars until an anticipated summer showdown over raising the debt ceiling.

The budget plan was passed by a 50-49 vote in the Democratic-controlled chamber. Four Democratic senators facing tough re-election campaigns in 2014 joined all the Senate Republicans in opposing the measure, which seeks to raise nearly $1 trillion in new tax revenues by closing some tax breaks for the wealthy.

The Senate budget, which reflects Democratic priorities of boosting near-term job growth and preserving social safety net programs, will square off in coming months against a Republican-focused budget passed by the Republican-dominated House of Representatives.

Neither of the non-binding blueprints has a chance of passage in the opposing chamber, leaving Congress no closer to resolving deep differences over how to shrink U.S. deficits and grow the economy. But they give each party a platform from which to tout their respective fiscal visions.

The Democrats' plan from Senate Budget Committee Chairman Patty Murray aims to reduce deficits by $1.85 trillion over 10 years through an equal mix of tax increases and spending cuts.

The Republican plan from House Budget Committee Chairman Paul Ryan seeks $4.6 trillion in savings over the same period without raising new taxes. It aims to reach a small surplus by 2023 through deep cuts to health care and social programs that aid the poor.

Murray said after the vote that she would try to work with Ryan on a path toward compromise.

"While it is clear that the policies, values, and priorities of the Senate budget are very different than those articulated in the House budget, I know the American people are expecting us to work together to end the gridlock and find common ground, and I plan to continue doing exactly that."

SHUTDOWN THREAT

Passage of a stop-gap government funding measure on Thursday lowered the temperature in the budget debate by eliminating the threat of a government shutdown next week.

"We're going to get a breather here. Congress will let things cool off a bit and there'll be other issues that come to the forefront in the spring," said Greg Valliere, chief political strategist at Potomac Research Group, a firm that advises institutional investors on Washington politics.

These issues include legislation on gun control, immigration reform and initial work on simplifying the tax code, which is particularly important to Republicans.

Joining Republicans in opposing the Democratic budget were Democratic senators from conservative-leaning states: Max Baucus of Montana, Mark Begich of Alaska, Kay Hagan of North Carolina and Mark Pryor of Arkansas. Voting for a budget that raises tax revenues could increase their vulnerability in congressional elections next year and put Democrats' thin majority at risk.

In the lead-up to the Senate vote early on Saturday morning, the body considered more than 100 largely symbolic, non-binding amendments to the budget aimed at scoring political points and staking out positions.

Among notable amendments, the Senate signaled strong support for allowing states more authority to collect sales taxes on Internet purchases, for approval of the controversial Canada-to-Texas Keystone XL oil pipeline and for repealing a tax on medical devices imposed by President Barack Obama's health care reform law.

The Senate also voted 99-0 to end policies that subsidized large banks considered "too big to fail" but came out against imposing taxes on industrial carbon emissions.

Ryan's plan aims to reach a small surplus with no tax increases by 2023 through deep cuts to social safety net programs. This enables Republicans to claim that they are more responsible by balancing the budget.

"The House budget changes our debt course, while the Senate budget does not," said Senator Jeff Sessions, the top Republican on the Senate Budget Committee.

BATTLE OVER "BALANCE"

In a taste of the ideological debates to come, Murray claimed that the Senate budget was more "balanced" because it emphasized job growth and offered an equal amount of revenue increases and spending cuts.

For a side-by-side comparison of the Ryan and Murray budgets, see here.

The Senate had not passed a budget resolution since 2009 because of fiscal policy disputes with House Republicans that forced Congress to turn to numerous stop-gap spending measures to avoid government shutdowns.

To protect their thin Senate majority, Democrats avoided exposing their members to potentially damaging votes to raise taxes ahead of 2012 elections, arguing that a 2011 budget deal set spending levels for several years and made the non-binding budget legislation unnecessary.

But this year, under the February debt limit increase law, members of both the House and Senate faced pay suspensions if their chamber had failed to pass a budget by April 15.

Although lawmakers in both parties have called for a return to normal budgeting procedures after years of stop-gap spending bills and high-pressure deadlines, there is little chance that they can work out differences between the two budgets.

"The idea of conferencing them is kind of a joke. You would expect that if there were a chance of success, they wouldn't have planted flags on completely different planets," said Sean West, U.S. policy director at Eurasia Group, a political risk consultancy.

Ultimately, it may take another 11th-hour deal between Obama and congressional Republicans to set a fiscal path forward as part of a deal to raise the debt ceiling, he said. The U.S. Treasury is expected to exhaust its borrowing capacity around late July or early August.

In 2011, a similar fight over the debt limit shook financial markets and cost the United States its top-tier credit rating.

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UPDATE 1-Cyprus poses no systemic threat to Russian banks -Russia central bank

Fri Mar 22, 2013 6:38am EDT

By Oksana Kobzeva

MOSCOW, March 22 (Reuters) - The financial crisis in Cyprus poses no systemic threat to the Russian banking system, a first deputy chairman of Russia's central bank, Alexei Simanovsky, said on Friday.

"I don't see any systemic or individual threat here," Simanovsky said, after the regulator conducted an "express-analysis" of links between Russian banks and Cyprus.

Cyprus's finance minister left Moscow empty-handed on Friday after Russia turned down appeals for aid, leaving the island to strike a bailout deal with the European Union before Tuesday or face the collapse of its financial system.

The Russian economy has a relatively low dependency on its banking system, with the ratio of total assets to gross domestic product ratio at 79.4 percent as of March 1, compared to over 100 percent in some developed countries.

After a proposed levy on bank deposits was rejected, Cypriot lawmakers are looking into other measures to raise at least part of 5.8 billion euros ($7.50 billion) required by the European Union as a condition for Cyprus to secure a 10 billion euro bailout.

Cypriot authorities are calling to impose capital controls to stem a flood of funds leaving the island when banks reopen, which they are expected to do on Tuesday after a week-long shutdown.

Ratings agency Fitch said on Thursday that Russian banks could face significant operational risks only if the crisis was prolonged and brokers and became reluctant to trade with Cyprus-based counterparts.

Russian banks do not see significant losses from the proposed levy.

Russian banks had $30 billion to $40 billion tied up in cross-border loans to Cypriot firms at the end of 2012 and some $12 billion on deposit with Cypriot banks, Moody's said earlier.

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UPDATE 1-Schroders in talks to buy Cazenove Capital

Fri Mar 22, 2013 6:42am EDT

LONDON, March 22 (Reuters) - British fund manager Schroders said on Friday it was in talks to buy smaller rival Cazenove Capital, raising the prospect of a marriage between two of London's oldest names.

In a regulatory statement, Schroders confirmed it was considering a cash offer for Cazenove, which manages 18.7 billion pounds ($28.39 billion) in assets, with a loan note alternative, for the firm's entire issued share capital.

Schroders has until April 19 to decide on whether to bid for the company, under UK takeover regulations.

Buying Cazenove would increase Schroders' assets under management by close to 10 percent. Last month 200-year old Schroders said assets had risen to 212 billion pounds following strong inflows in its fourth quarter.

Traditionally one of the least acquisitive of the larger UK asset management houses, Schroders has made small add-on deals recently. In December it said it had agreed to buy U.S.-based STW Fixed Income Management.

Cazenove, established in 1823, had by the 1940s become one of the top stockbroking firms for the well-heeled of London.

The fund management arm was split from the wider group after JP Morgan formed a joint venture with Cazenove's UK investment banking business in 2005.

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Cyprus agrees to spin off Greek units of Cypriot banks

NICOSIA, March 22 | Fri Mar 22, 2013 6:53am EDT

NICOSIA, March 22 (Reuters) - Cyprus has agreed with Greece on a takeover of the Greek units of Cypriot banks, the island nation's presidency said on Friday, ending uncertainty over the fate of those operations.

"After talks between Cyprus President Nicos Anastasiades with Greek Prime Minister Antonis Samaras, it was confirmed that the spinoff issue of Greek branches of Cypriot banks has been settled with the most favourable terms under the present circumstances, with a significant benefit for the Cypriot side," the Cypriot presidency said in a statement.

Euro zone finance ministers excluded the Greek branches of Cypriot banks from a controversial tax included in the island's international bailout on condition that those units would be transferred to Greek banks.

A least two of Greece's biggest lenders have showed interest in the Cypriot units, government officials and bankers told Reuters earlier this week.

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UPDATE 1-Spain beats bond sale target, brushes off Cyprus crisis

Thu Mar 21, 2013 6:26am EDT

* Spain sells 4.5 billion euros of debt at triple-bond sale

* Average yields lower on all three bonds

* Spain has sold more than 34 percent of 2013 bond issuance goal

By Paul Day

MADRID, March 21 (Reuters) - Spain sold more than planned at a bond auction on Thursday at yields slightly below those paid at sales over the last month, with investor appetite undimmed by the financial crisis in Cyprus.

The Treasury sold 4.5 billion euros ($5.8 billion) at the sale of three maturities, including the 10-year benchmark, beating the top end of its target range of 3 to 4 billion euros.

"It's a very good auction ... Contagion fears for the time being are not materialising and we believe this is going to continue," rate strategist at Commerzbank in London Michael Leister said.

Spain has now sold more than 34 percent of its total 2013 goal as it makes the most of renewed investor appetite in high-yielding debt, backed by the European Central Bank's pledge last summer to do whatever was necessary to protect the monetary union.

Cyprus has faced the prospect of bankruptcy since Tuesday, when its parliament voted unanimously against a levy on bank deposits and continues to search for a new plan to find billions of euros to qualify for European aid.

But Spain's dire economy, which is not expected to emerge from its more than a year-long recession until next year, massive unemployment and high deficit have become less of a worry for investors since the ECB plan to buy distressed members' bonds.

"(The sale has) gone very well. Clearly there is no Cyprus angst or Italy angst in that sale. They sold more than they were targeting," said Marc Ostwald, strategist at Monument Securities in London.

"It is basically people reaching for yield. You can't make any returns in Bunds, or in gilts or in Treasuries."

The risk premium investors demand to hold Spanish over German debt fell sharply after the auction, to around 347 basis points, a long way from euro-era highs last July of around 650 bps.

On Thursday, the Treasury sold 1.2 billion euros of a bond due March 31, 2015, at an average yield of 2.275 percent compared to 2.540 percent when it last sold Feb. 21. The bond was 4 times subscribed after 3.7 times in February.

The bond maturing Jan. 31, 2018 sold 1.0 billion euros, while yields fell to 3.557 percent from 3.572 percent just two weeks ago, with a bid-to-cover ratio of 3.6 compared to 2.3 previously.

The yield on the longer-dated, benchmark bond, due Jan. 31, 2023 was 4.898 percent compared to 4.917 percent at the beginning of March, with demand outstripping supply by 1.9 times compared to 2.3 times previously.

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UPDATE 1-British budget deficit and retail data offer rare positive news

Thu Mar 21, 2013 6:25am EDT

By David Milliken and Christina Fincher

LONDON, March 21 (Reuters) - Britain had a far smaller-than-expected deficit in February and retail sales got a boost, data showed on Thursday, a fillip for finance minister George Osborne a day after he released dismal economic forecasts.

Deficit reduction is the central economic policy of Britain's Conservative-led coalition government, which came to power in May 2010 when Britain's budget deficit was more than 11 percent of annual economic output - one of the highest for a major economy.

The government's budget plans have been plagued by weak growth, but retail sales figures released at the same time as the borrowing figures suggested at least some temporary relief after a dismal January for retailers.

The government's preferred measure of Britain's public borrowing, which strips out some of the effects of its bank bailouts, showed a deficit of just 2.756 billion pounds in February, the Office for National Statistics said on Thursday.

This is roughly a quarter of the 11.756 billion seen in February 2012 and far below analyst forecasts of deficit of 8.45 billion pounds.

The statistics office did not translate this into a percentage of output, or gross national product. Osborne announced on Wednesday that GDP would grow just 0.6 percent this year, half the previous prediction.

Britain is teetering on the brink of its third recession in four years - something Thursday's data may help it avoid. Growth is better than in the euro zone which is expected by many to contract this year. But it pales against other countries.

Sterling rose to a two-week high against the dollar and a five-week high against the euro after the data.

February's figures are flattered by a known 2.6 billion pound transfer of cash from the Bank of England under a deal to return gilt interest to the government, and 2.3 billion pounds from the sale of next-generation mobile phone frequencies.

But underlying performance was also strong, with a drop in local government spending and stronger central government tax receipts.

"It's mildly encouraging and we can see why sterling rallied on the back of that news," said Tom Vosa, economist at National Australia Bank. "Public sector borrowing now looks to be in line with the stronger employment growth and perhaps again more consistent that we have avoided the technical recession."

Separate official data showed that retail sales volumes rose 2.1 percent on the month, versus expectations for a 0.5 percent rise, and were 2.6 percent higher on the year - both the strongest rises since March 2012.

A bounce back from a snowy January and strong demand for tablet computers, sports goods and jewellery helped sales, the statistics office said.

Still, there were signs of weakness in the retail sector. Next, Britain's second-biggest clothing retailer, said trading in its new financial year had got off to a slow start.

Thursday's data showed Britain's total public debt, excluding the cost of bailing out its banks, rose to 1.1615 trillion pounds, equivalent to 73.5 percent of annual economic output, just shy of December's record 75.1 percent.

Since the start of the tax year in April 2012, borrowing has totalled 94.9 billion pounds, excluding a one-off boost from the transfer of Royal Mail pension assets.

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WRAPUP 4-ECB gives Cyprus bailout ultimatum, banks face cutoff

Thu Mar 21, 2013 6:34am EDT

* Finance minister discussing banking, energy cooperation with Russia

* President meets party leaders on "Plan B"

* ECB says to cut off bank funds without bailout deal by Monday

* Russia says EU behaving like "bull in a china shop"

* Eurogroup chairman says Russia won't lend Cyprus more

By Michele Kambas and Paul Carrel

NICOSIA/FRANKFURT, March 21 (Reuters) - The European Central Bank gave Cyprus until Monday to raise billions of euros to clinch an international bailout or face losing emergency funds for its banks and inevitable collapse.

The ultimatum came with the island's leaders locked in talks on a "Plan B" to try to raise 5.8 billion euros demanded by the EU under a 10 billion euro ($13 billion) rescue, after angry lawmakers threw out a tax on deposits as "bank robbery".

Officials said new options discussed on Thursday could include nationalising pension funds of semi-state companies, issuing an emergency bond linked to future natural gas revenue or a revised bank deposit levy hitting only large investors, many of them Russians.

The European Central Bank, which has kept Cyprus's banks operating with a liquidity lifeline, said the government had until Monday to get a deal in place, or funds would be cut off.

"Thereafter, Emergency Liquidity Assistance (ELA) could only be considered if an EU/IMF programme is in place that would ensure the solvency of the concerned banks," it said.

Cyprus's central bank governor said he expected to clinch a financial support package by then. He did not say how.

The government has ordered banks to stay closed until Tuesday. The stock exchange also suspended trading for the rest of the week.

There were long queues at some bank branches in Nicosia as staff replenished cash machines, which have continued to operate while banks have been closed since last week.

In Moscow, Cypriot Finance Minister Michael Sarris said he was discussing possible Russian investments in the island's banks and energy resources to reduce its debt burden, as well as an extension of an existing 2.5-billion-euro Russian loan.

Russian citizens have billions of euros to lose in the island's outsized, teetering banking sector.

"The banks are the ultimate objective in any support we get, so it'll either be a direct support to the banks or the support that we get through other sectors will be channelled to the banks," Sarris told Reuters during a second day of talks with his Russian counterpart, Anton Siluanov.

He said Cyprus had no plans to borrow more money from Russia and add to its debt mountain. The Russian Finance Ministry had said on Monday that Nicosia sought an extra 5 billion euro loan.

The chairman of euro zone finance ministers, Dutchman Jeroen Dijsselbloem, told the European Parliament Moscow had informed the EU that it had no intention of ploughing more money into Cyprus beyond the existing loan.

"Any other options, to go further, another loan or an investment in the banks, the Russians let us know that they are not willing to do that," he said. "Of course, the Cypriot government is now talking to the Russian government whether more can be done, I don't know the outcome of that yet."

Dijsselbloem said new loans from Russia would anyway not solve the debt issue, and that a revised levy on larger bank deposits was still on the table.

"I'm not sure that this package is completely gone and failed, because I don't see many alternatives," he told the European Parliament in Brussels.

EU officials believe at least some of the 5.8 billion they are demanding should come from the 68 billion euros in Cypriot banks, 38 billion of which are in the form of large deposits of more than 100,000 euros, mainly from foreigners.

But hitting small savers caused visceral outrage, and the Cypriot government fears that foisting too big a burden on large depositors would wreck the offshore financial industry that forms much of the country's economy.

Among the other options, nationalising pension funds of semi-public companies could yield between 2 billion and 3 billion euros, although European officials say it would raise less. Issuing bonds linked to future natural gas revenue is problematic because pumping any gas is years away.

INSOLVENCY

Doubts about the fate of the small nation of just 1.1 million people has shaken confidence in the single-currency euro zone and raised geopolitical tension between the EU and Russia.

Russian Prime Minister Dmitry Medvedev, who meets a European Commission delegation in Moscow on Thursday, said the bloc had behaved "like a bull in a china shop". He likened EU proposals, which would force Russian customers to contribute to the rescue of Cypriot banks, to Soviet-era expropriations.

Tuesday's parliamentary vote marked a stunning rejection of the kind of strict austerity accepted over the past three years by crisis-hit Greece, Portugal, Ireland, Spain and Italy.

European officials maintained the pressure on Nicosia.

"I cannot rule out a Cyprus insolvency," Austrian Finance Minister Maria Fekter said in an interview with the newspaper Oesterreich. "A euro exit would not achieve anything. Cyprus must act now."

With Cypriot Energy Minister George Lakkotrypis also in Moscow, officially for a tourism exhibition, speculation was rife that access to untapped offshore gas reserves could be on the table as part of a deal for Russian aid.

Cyprus is a haven for billions of euros squirreled abroad by Russian businesses and individuals - one of the reasons why Germany and other northern euro zone states are reluctant to bail it out without a contribution from bank depositors.

The island's banking sector was hollowed out by its exposure to bigger neighbour Greece.

The proposed levy on deposits would have taken nearly 10 percent from accounts over 100,000 euros. Smaller accounts would also have been hit, although the government proposed softening the blow to spare savers with less than 20,000 euros.

Cypriots were enraged at the proposal to tax accounts with less than 100,000 euros, which are meant to be protected by state guarantees across the European Union.

Marinos Panaretou, a 36-year-old retail manager, said he had been withdrawing the maximum 500 euros every day since Saturday, when news broke of the proposed levy.

"People feel safer if we have cash on us because you don't know what you're going to wake up to," he said. "Quite simply, you don't know what's going to happen tomorrow."

European officials say the Cypriot government could have protected small savers if it imposed a higher tax on big deposits, but it refused to do so to protect the rich foreign clients of its offshore banking business.

EU leaders are growing increasingly exasperated with Cyprus, while the threat of bankruptcy for a member of the euro zone, however small, raises fears for confidence in the currency.

"There is no obligation to accept help," said Polish Foreign Minister Radoslaw Sikorski, whose country does not use the euro. "Cyprus has the possibility of living with its own mistakes."

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UPDATE 1-Italian president seeks way out of political stalemate

Wed Mar 20, 2013 6:41am EDT

* Consultations with parties due to run to Thursday

* No sign of end to stalemate after inconclusive election

* Prospect of early return to polls if no accord reached

By James Mackenzie

ROME, March 20 (Reuters) - Italian President Giorgio Napolitano began consultations with political leaders on Wednesday to try to find a way of forming a government after the deadlocked election last month which left no party with a majority in parliament.

Senate speaker Pietro Grasso said after meeting Napolitano the president was determined to reach an accord, saying there was "an absolute necessity to give the country a government".

Napolitano would take "all roads possible", he said.

Italy's political stalemate and the prospect of months of uncertainty has created alarm across Europe just as the standoff over bank deposits in Cyprus reawakened fears that the euro zone debt crisis could flare up again.

Centre-left leader Pier Luigi Bersani, who won a majority in the lower house but not in the Senate, commands the largest bloc in parliament but cannot govern unless he has support from one of the other parties.

However, there has been no sign that an accord is possible with either former Prime Minister Silvio Berlusconi's centre-right alliance, the second biggest force in parliament, or the anti-establishment 5-Star Movement led by ex-comic Beppe Grillo, which holds the balance of power.

If no agreement can be struck between parties that are bitterly divided, Italy faces the prospect of a brief period under a caretaker government followed by a return to the polls, possibly as early as June.

Napolitano also meets minor parties, including Prime Minister Mario Monti's centrist group on Wednesday before the main meetings on Thursday when he sees representatives from the 5-Star Movement, Berlusconi's People of Freedom (PDL) party and Bersani's Democratic Party (PD).

Bersani, 61, received a small boost at the weekend when his candidates were elected the speakers of the two houses of parliament, despite the centre left's lack of a majority in the upper house.

Both speakers announced late on Tuesday that they would take a 30 percent wage cut and urged other parliamentarians to do the same, a move that followed an example set by 5-Star members elected as local officials in Sicily last year who gave up most of their salaries and used the savings to fund small businesses.

LIMITED

Bersani is proposing to present a limited package of reforms aimed at fighting corruption and creating jobs that he hopes can be backed by the 5-Star Movement.

Given the fractious climate, the prospects of a minority government surviving more than a short time are slim but Bersani has little alternative.

"The PD is not changing our line, we'll go to the consultations with the proposals which were voted by the party leadership immediately after the election," he told reporters on Tuesday.

Italy, the euro zone's third-largest economy, can ill afford a prolonged political crisis after the turmoil which brought down Berlusconi's last government and dragged the single currency to the brink of disaster just 16 months ago.

Its economy is deep in recession, and unemployment is at record levels especially among the young. Its 2 trillion-euro ($2.6 trillion) public debt is dangerously vulnerable to bond market volatility and any sharp rise in interest rates.

However, far from prompting the parties to cooperate as they did when Monti's technocrat government took over from Berlusconi in 2011, the crisis appears to have deepened hostility.

Grillo, who has pledged not to give a vote of confidence to a government led by any other party, warned followers against falling into a "trap" after a handful of rebels voted with the centre left in the election of the Senate speaker on Saturday.

Berlusconi, fighting a tax fraud conviction and facing trial for paying for sex with a minor, has demanded that the centre right be allowed to name the next president when Napolitano's term ends on May 15, offering his support to a Bersani-led government in exchange.

That offer was rejected as "indecent" by the PD, prompting Berlusconi to pledge street protests if parliament appointed a centre-left head of state.

A rally organised by the PDL, called "All for Silvio!" is already planned for Saturday to protest against what his supporters say is a political campaign by magistrates against the 76-year-old billionaire.

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