By James Mackenzie
ROME (Reuters) - Prime Minister Silvio Berlusconi backed Italy's deficit reduction targets Friday after markets took fright at fresh signs of government tension and problems for Economy Minister Giulio Tremonti.
Tremonti, caught on film this week calling one of his ministerial colleagues a "cretin," has appeared increasingly isolated in the cabinet and came under pressure Friday in the wake of corruption accusations against a former aide.
But he remains the minister most trusted by financial markets to keep control of Italy's badly strained public finances and prevent it being drawn into the market turmoil that has hit countries like Greece, Spain and Portugal.
In an interview with the daily La Repubblica published on Friday, Berlusconi declared he would not run again when his term ends in 2013 and named 40 year-old Justice Minister Angelino Alfano as his successor.
He has said similar things in the past but he also made disparaging comments about Tremonti, who pushed a tough austerity program through cabinet last week in the teeth of considerable grumbling from several of his colleagues.
"You know, he thinks he's a genius and that everyone else is stupid," Berlusconi said. "I put up with him because I've known him for a long time and one has to accept the way he is. Buthe's the only one who is not a team player."
Later Friday he announced he had invited Tremonti to a meeting at his residence in Rome, where the minister was seen arriving at around 2:30 p.m. (1230 GMT) before leaving some 45 minutes later without speaking to reporters.
In a statement issued after what was described as a "long and cordial working lunch," Berlusconi said he and Tremonti had discussed "the most current problems including the fiscal correction measures for the continuation and reinforcement of the action of the government."
"Prime Minister Berlusconi repeated the aim of the Italian government to reach budget balance by 2014 in line with commitments assumed at the European level," the statement said.
The problems facing Tremonti grew after Naples prosecutors filed a request for the arrest of Marco Milanese, who up until last week was a close adviser to the minister.
Milanese, a member of parliament for the ruling People of Freedom party, is accused of accepting jewelry, luxury cars and other presents from Paolo Viscione, a businessman arrested last year for fraud.
Tremonti, who until Thursday night used to stay in a residence belonging to Milanese for part of each week when he was working in Rome, issued a statement saying he had moved out after magistrates raised the graft allegations.
Friday, market pressure on Italy rose sharply, fueled a mix of worries about Tremonti's future, concern over the banking sector and fresh doubts over whether chronically sluggish growth would allow it to cut its huge public debt.
DRAGHI BACKS AUSTERITY PACKAGE
As Italian bond yields jumped to record levels and Italian bank shares dropped sharply, Bank of Italy Governor Mario Draghi, the next head of the European Central Bank, issued a statement supporting austerity measures piloted by Tremonti.
Berlusconi has repeatedly stated his confidence in Tremonti in the face of more or less open attacks from other members of the cabinet, irritated by his sometimes abrasive manner and his insistence on electorally unpopular austerity measures.
As speculation over Tremonti's future swirled, the premium investors demand to hold Italian rather than benchmark German bonds rose as high as 236 points, the widest spread since the launch of the euro more than a decade ago.
Bank shares also fell, hit by both political uncertainty and worries the sector may need more capital after European Union bank stress tests [ID:nLDE7670OT].
"Sentiment has changed on Italy, which in the eyes of the markets is now closer to Spain," said Alessandro Tentori, a market strategist at BNP Paribas.
Italy, with a public debt equivalent to some 120 percent of gross domestic product has so far escaped the worst of the euro zone debt crisis, thanks to rigid control of public spending, a conservative banking system and relatively high private savings.
But uncertainty over whether Berlusconi's struggling government can drive reforms sufficient to generate the kind of growth needed to cut back the debt has brought it increasingly into the focus of the markets.
Rating agencies Moody's and Standard and Poor's both have warned that they could downgrade Italy's credit rating if growth does not improve.
(Additional reporting by Elvira Pollina in Milan, Giuseppe Fonte and Francesca Piscioneri in Rome; Editing by Michael Roddy)