* In emotional outburst, Napolitano says parties must act
* Grand coalition could be formed in coming days
* President, 87, fights back tears as he condemns politicians
Newly re-elected president Giorgio Napolitano delivered an emotional rebuke to Italy's warring political factions on Monday and announced talks that could see a grand coalition government formed within days to end two months of post-election stalemate.
The 87-year-old Napolitano said he had only accepted an unprecedented second term as head of state because of the "dramatic alarm" facing Italy since national elections on Feb. 24 and 25 left no party able to govern alone.
In an inaugural address to parliament, two days after it elected him, he called for the swift formation of a new government backed by the main political parties. He said they needed to uphold Italy's commitment to European Union allies, who have seen deadlock in Rome trouble their common currency.
Financial markets rose in response to the weekend vote for the presidency, a post that is largely ceremonial but which has a key role in steering the formation of coalition governments.
Accusing the parties and their leaders of "irresponsibility" and threatening to resign if they failed to cooperate with him now in the national interest, Napolitano choked back emotion as he said the parliamentary election result had created "the unavoidable necessity of an understanding between the different political forces to give birth to and maintain a government".
In a statement issued after the speech, he said he would begin a "rapid series of meetings" with parliamentary leaders but made clear that they would not involve long consultations, suggesting a government could be in place within a day or two.
His voice occasionally breaking as he fought back tears, Napolitano chastised the parties for obstructing his efforts to push them towards agreeing reforms to revive Italy's stagnant economy and often ineffective political institutions.
Accusing the very parties which had begged him to remain in office despite his reluctance of being deaf to his past appeals during two months of negotiations on a government, he said he would not tolerate further refusal to do what was needed to pull Italy out of crisis. He threatened to resign if ignored again.
"I have a duty to be frank. If I find myself once again facing the kind of deafness I ran into in the past, I will not hesitate to draw the consequences," he said.
The speech was at times interrupted by thunderous applause as the listening parliamentarians cheered the relentless dissection of their flaws offered by Napolitano, a former communist veteran of decades in the upper reaches of Italian politics.
He said the failure to reform a dysfunctional electoral law which had contributed to the political deadlock was "unpardonable" and accused the parties of a "long series of omissions and failures, obstruction and irresponsibility".
Napolitano's re-election and the prospect of an end to the stalemate was welcomed by financial markets; the main barometer of investor confidence, the spread of yields on 10-year Italian bonds over their safer German counterparts, narrowed sharply and Italian stocks were among the main gainers across Europe.
Napolitano yielded to the pleas of the bickering parties on Saturday after parliament had failed in repeated votes involving several other candidates to elect a successor.
Giuliano Amato, a former prime minister aged 75, is considered Napolitano's favourite to head a new administration likely to be a mix of technocrats and politicians from the main parties except the anti-establishment 5-Star Movement.
However, worries about the future stability of a government that will need the support of parliament to survive were underlined by deep divisions in the centre-left Democratic Party (PD), which is close to self-destruction having won a majority of seats in the lower house but lacks control in the Senate.
PD leader Pier Luigi Bersani announced his resignation from his party post on Friday after factional rebels sabotaged two attempts to elect a centre-left candidate as president, leaving rival groups fighting for control.
The turmoil in the PD has left centre-right leader Silvio Berlusconi with a decisive advantage but has made it more difficult to ensure that divided centre-left parliamentarians will provide solid support to a new government.
The 5-Star Movement, the third largest force in parliament, protested against Napolitano's re-election and will oppose the new government, which its founder, comedian Beppe Grillo, said would be created only to protect a discredited political class.
In a sign of its dissent from most of the rest of parliament, members of the newly potent protest movement stood but did not applaud as Napolitano took his oath of office.
Berlusconi's People of Freedom (PDL) party insisted it would only accept a coalition government giving it a share of power with the PD, which won control of the lower house but fell short of a full majority in parliament in the election in February.
It is also expected to press for an end to the austerity policies followed by outgoing Prime Minister Mario Monti's technocrat government to combat the financial crisis that ended Berlusconi's last term as prime minister in 2011.
"After the very bad experience of the government," the media tycoon told La7 television, "I think that it's time that the politicians get involved again."