* Berlusconi could block centre-left government
* Centrist Monti, outgoing prime minister, slumps
* Market reaction reverses after Senate projection
Projections from an early vote count in Italy's election on Monday showed Silvio Berlusconi's centre right slightly ahead in the Senate, a result that could cause deep government instability if confirmed.
The projections on RAI, Sky, Mediaset and LA 7 television stations were the reverse of earlier predictions from telephone polls that showed the centre left taking a strong lead in both houses of parliament.
The change in predictions had an immediate impact on markets which rose earlier on hopes of a stable and strong centre-left led government.
Such a government, probably backed by outgoing technocrat premier Mario Monti, is seen as the best guarantee of measures to combat a deep recession and stagnant growth.
Berlusconi's aim is to win enough power in the Senate to paralyse a centre-left-led government.
The benchmark spread between Italian 10-year bonds and their German equivalent widened from below 260 basis points to above 280 and the Italian share index lost previous gains.
The earlier telephone polls on Sky and Rai television after voting ended at 3 p.m. (1400 GMT/9 a.m. ET) had showed the centre left of Pier Luigi Bersani 5-6 points ahead of the centre right in both Senate and lower house, with the anti-establishment movement of Genoese comedian Beppe Grillo taking third place.
But early projections on RAI television and based on a small sample of the 47 million electorate showed Berlusconi's coalition, which includes the federalist Northern League, ahead of Bersani in the Senate by just over 2 percentage points. The projections still placed Grillo third.
Italy's electoral laws guarantee a strong majority in the lower house to the party or coalition that wins the biggest share of the national vote.
However the Senate, elected on a region-by-region basis, is more complicated and the result will turn on four key battleground regions. Projections from LA 7 showed Berlusconi winning in three of them: Lombardy, Sicily and Campania.
The RAI projection showed him strongly ahead in the rich northern region Lombardy, with 31.6 percent against 29.4 percent for the centre left, with Grillo on 24.9 percent.
Italy, the euro zone's third largest economy, is pivotal to stability in the currency union.
A bitter campaign, fought largely over economic issues, has been closely watched by financial markets, anxious about the risk of a return of the kind of debt crisis that took the euro zone close to disaster and brought the technocrat Monti to office, replacing the scandal-plagued Berlusconi, in 2011.
Monti helped save Italy from a debt crisis when Rome's borrowing costs were spiralling out of control, but the polls and projections suggested few Italians now see him as the saviour of the country, in its longest recession for 20 years.
A surge in protest votes for Grillo's 5-Star Movement had raised uncertainty about the chances of a stable government that could fend off the danger of a renewed euro zone crisis.
Grillo's movement rode a huge wave of voter anger about both the pain of Monti's austerity programme and a string of political and corporate scandals. It had particular appeal for a frustrated younger generation shut out of full-time jobs.
"I'm sick of the scandals and the stealing," said Paolo Gentile, a 49-year-old Rome lawyer who voted for 5-Star.
"We need some young, new people in parliament, not the old parties that are totally discredited."
Bad weather, including heavy snow in some areas, was thought to have hampered the turnout in Italy's first post-war election to be held in winter. This could have favoured the centre left, whose voters tend to be more committed than those on the right, which has strong support among older people.
The 76-year-old media tycoon Berlusconi pledged sweeping tax cuts and accused Monti of being a puppet of German Chancellor Angela Merkel in a media blitz that halved the lead of the centre left since the start of the year.
Whatever government emerges will inherit an economy that has been stagnant for much of the past two decades and problems ranging from record youth unemployment to a dysfunctional justice system and a bloated public sector.