ROME (Reuters) - Centre-left leader Romano Prodi claimed victory in Italy's election on Tuesday but his tiny margin raised fears of political paralysis and Prime Minister Silvio Berlusconi's allies refused to concede defeat.
Prodi's alliance won narrowly in the lower house and Sky Italia TV projected that it would have a majority of one or two seats in the upper house Senate thanks to votes of Italians abroad that were still being counted.
"We can govern for five years," Prodi told reporters. "My government will be politically and technically strong."
However, Prodi's victory in the Senate was still not official more than 24 hours after polls closed.
And his margin in the lower house Chamber of Deputies was so slim that the centre-right demanded a review of the count, raising the prospect of a lengthy wait before a final outcome.
Berlusconi planned to speak to the press at 6:30 p.m. (1630 GMT), breaking his stony silence since before the vote, aides said without indicating if he would demand a recount.
Markets worried that Prodi would be a lame duck premier, unable to enact reforms, cut Italy's debt or tackle its budget deficit. Milan's stock market fell and the cost of government borrowing rose over concern about the political uncertainty.
"It's highly unlikely that the kind of majority we will see can pass the necessary reforms," Susana Garcia of Deutsche Bank said.
In the lower house, Prodi's winning margin was around 25,000 votes, a minuscule fraction of the 47 million eligible electors. Final Senate results were expected later on Tuesday.
"It's going to be a mess," Silvano Cazzaniga said from behind the sandwich counter in his Milan cafe.
Prodi said he was awaiting a phone call from Berlusconi to concede defeat, "because this is what happens in modern democracies".
But Berlusconi, who wrong-footed his opponents with a last minute pledge to scrap a property tax, stayed out of sight while his allies demanded checks on half a million spoilt ballots.
In an apparent bid to head off any messy battle over the result, President Carlo Azeglio Ciampi, the supreme arbiter of Italian politics, issued a statement praising the "orderly and correct" voting process.
And in a snub to Berlusconi's alliance as it held back from conceding, France and Luxembourg offered the first international stamps of approval for Prodi's coalition.
French European Affairs Minister Catherine Colonna said in a congratulatory message to Prodi that he would "play an essential role in the relaunching of Europe".
But frustrated Italians feared paralysis and instability.
"I think we'll have a government that lasts six months," said Pietro Bianchi, a Milan banker.
Under Italy's new electoral system, Prodi's coalition was awarded 341 of the lower house's 630 seats despite its margin of victory of under 0.1 percent. Berlusconi's alliance was awarded 277, with 12 overseas seats yet to be allocated.
Centre-right politicians said the number of spoilt ballots outnumbered Prodi's margin. "Such a tiny difference necessitates a scrupulous checking of the counting," said Paolo Bonaiuti, a top Berlusconi aide.
It was unclear how sweeping a recount the centre-right might demand, how long it could take or whether the battle would end up in Italy's notoriously slow legal system.
Even a partial recount would delay a definitive verdict and with it Italy's prospects of reviving its stagnant economy.
Fitch Ratings agency said Italy could face a downgrade unless the new government quickly put public finances in order. But Moody's said it saw no direct link between Prodi's narrow win and the probability of default.
Prodi quickly sought to reassure markets, saying his Senate margin would be wider than after his 1996 victory over Berlusconi. Prodi lasted two years before his government fell.
"The electoral result will force us to work with greater attention," said Prodi.
Prodi's centre-left bloc, which stretches from Roman Catholic centrists to committed communists, had expected a comfortable victory in the election, tapping into voter unhappiness over the stagnant economy and rising cost of living.
Prodi, a former European Commission president, said he would put Europe at the centre of his new administration and promised a "constructive relationship" with the United States.
Berlusconi is U.S. President George W. Bush's closest ally in continental Europe, deploying troops to Iraq in the face of widespread protests at home. Prodi has vowed to withdraw the troops following consultations with allies.
(Additional reporting by Silvia Aloisi, Philip Pullella, Rachel Sanderson, Roberto Landucci, Stefano Bernabei in Rome; Lisa Jucca, Valentina Za in Milan)