By James Mackenzie
ROME (Reuters) - Italy's 87-year-old President Giorgio Napolitano will face the greatest test of his career during his final weeks in office as he tries to end the standoff preventing a new government being formed more than a month after elections.
Following widespread reports he may resign to open the way for a new vote, Napolitano pledged to remain in office at the Quirinale palace until his term ends on May 15, averting the immediate threat of further turmoil.
He named 10 "wise men" including European Affairs Minister Enzo Moavero and senior politicians from the main centre-left and centre-right blocs to propose a series of urgent measures that could be backed by all parties.
Details will be announced on Tuesday but are expected to include cutting the cost of the bloated political system and replacing the widely criticised electoral law to avoid a repeat of the deadlock in future elections.
"It would be a disaster to go back to an election without have reformed the electoral law," Valerio Onida, former head of the Constitutional court who is part of the advisory group, told La Repubblica newspaper.
With financial markets already concerned about instability in the euro zone's third-largest economy, the prospect of Napolitano leaving raised alarm and moves to escape the impasse received a cautious welcome from commentators on Sunday.
"It was the right decision, it will avoid sending a dangerous signal to the markets and will show Italian institutions are solid and functioning," Enrico Letta, deputy head of the centre-left Democratic Party told Reuters.
However, there were few illusions that summoning the "wise men", in line with a long tradition in Italian politics, offered more than a slim hope of overcoming the deep divisions that have prevented the parties from coming to an agreement.
"Political history shows, alas, that whenever someone wants not to decide something, what happens? They set up a nice commission," Daniela Santanche, a member of parliament close to former prime minister Silvio Berlusconi, told La Stampa.
She said there was no alternative to Berlusconi's demand to share power in a coalition with the centre-left formation led by Pier Luigi Bersani, which has repeatedly said it cannot deal with the scandal-plagued billionaire.
"Otherwise we go to elections, which we're sure of winning. There won't be any strange third ways," she said.
Napolitano, member of a student anti-fascist group during World War Two and a former communist, won wide respect in Italy and Europe for his handling of the 2011 political and financial market crisis which brought down the last Berlusconi government.
Newspapers reported on Sunday that European Central Bank President Mario Draghi called Napolitano to express concern his resignation would leave Italy without leadership at a time of mounting tension in financial markets.
However, Napolitano has acknowledged he has only limited power to force the parties to find a way out of political situation he said was "frozen between irreconcilable positions".
The three main blocs in parliament - Bersani's centre-left, Berlusconi's centre-right alliance and Beppe Grillo's anti-establishment 5-Star Movement - have all clung to demands that have prevented any government being formed.
Bersani, who won control of the lower house but fell short of the Senate majority that would allow him to govern, rules out a "grand coalition" with Berlusconi while Grillo refuses a pact with parties he blames for Italy's social and economic crisis.
Berlusconi and Grillo have both said they would not back a repeat of the kind of technocrat government led by Prime Minister Mario Monti, who will remain in office until a new government arrives.
The deeply divided parliament, along with regional representatives, will soon face the task of electing Napolitano's successor, who will have to oversee the birth of a new government or guide Italy into new elections.
Berlusconi, facing a verdict in his trial on charges of paying for sex with a minor as well as a decision on his appeal against a four-year sentence for tax fraud, has demanded the next president come from his side. He has already threatened to take protests to the streets if he does not get his way.
(Reporting By James Mackenzie; Editing by Sophie Hares)