* FTSE 100 closes up 0.3 percent
* Strong gains pared after projected divide in house control
* Sovereign downgrade could help FTSE - analysts
* Pearson falls on flat earnings expectations
By Alistair Smout
LONDON, Feb 25 (Reuters) - UK shares shed all of their early gains on Monday as projected Italian election results suggested a clear-cut winner was unlikely to emerge, diminishing the prospects for a stable government.
Early exit polls suggesting a healthy lead for a centre-left coalition led by Pier Luigi Bersani in both houses of parliament were confounded by projections based on early vote counts suggesting that Silvio Berlusconi's anti-austerity centre-right coalition was leading in the Senate.
Such a result would make a governing coalition difficult to form.
Britain's top share index lost one percent in under an hour in afternoon trade, turning a 0.9 percent gain at its peak shortly after 1500 GMT to a 0.2 percent fall at its trough around 1600 GMT after the first projections showed a centre-right majority in the Senate.
"The story of the afternoon is that sell-off after the numbers showed that Berlusconi is doing well, and that's taken the gloss off of what was a very strong day up to that point." Johnny Keaney, sales trader at Knight Capital, said.
The market recovered to finish in positive territory, aided by subsequent projection from IPR that said the centre-left was ahead in the Senate race.
The FTSE 100 closed up 19.67 points, or 0.3 percent, at 6,355.37, with initial gains being made on hopes of both centre-left success at the Italian elections as well as further monetary easing from Japan and the U.S.
Sectors which rise and fall with economic sentiment, such as banks, miners and energy companies - the so-called "cyclical" sectors - led gainers, combining to add 30 points to the index.
The rise came even though Britain lost one of its prized triple-A credit ratings late on Friday when Moody's downgraded it.
Some saw the Moody's downgrade as paradoxically good for the FTSE 100, as it placed downward pressure on sterling, potentially helping UK exporters, as well as possibly improving the case for a more supportive monetary policy.
"Data from FTSE 100 companies shows 27 percent of their revenue comes from growth markets, which we define as Asia and emerging markets in general," James Butterfill, Equity Strategist at Coutts, said in a note.
"A weaker currency not only makes UK exports more competitive, but also gives a greater boost to the UK than the euro or US markets, which derive 21 percent and 12.3 percent of their revenue from growth markets respectively. "
Berenberg Bank said the UK rating downgrade was likely to mean slightly looser monetary and fiscal policy, which usually benefits equities.
Meanwhile, Citi affirmed an overweight position on UK banks, seeing weak sterling as a positive for the sector and highlighting the outperformance of French banks following a sovereign downgrade late last year.
Banks gained 1.2 percent on the day.
British education and media group Pearson fell 3.7 percent, making it the heaviest faller on the FTSE 100, after saying it expects this year's earnings to be flat.
Pearson also saw the largest volume traded, with over four times its average 90-day volume traded by the close.
Reckitt Benckiser (RB) also fell in heavy volume, losing 3 percent after the U.S. drugs regulator rejected its call for stricter packaging for its heroin addiction treatment, instead approving generic production for the drug. (Editing by Toby Chopra)