French, Malian forces fight suspected Islamists in Gao

GAO, Mali (Reuters) - French and Malian troops fought Islamists on the streets of Gao and a car bomb exploded in Kidal on Thursday, as fighting showed little sign of abating weeks before France plans to start withdrawing some forces.

Reuters reporters in Gao in the country's desert north said French and Malian forces fired at the mayor's office with heavy machineguns after Islamists were reported to have infiltrated the Niger River town during a night of explosions and gunfire.

In Kidal, a remote far north town where the French are hunting Islamists, residents said a car bomb killed two. A French defense ministry source reported no French casualties.

French troops dispatched to root out rebels with links to al Qaeda swiftly retook northern towns last month. But they now risk being bogged down in a guerrilla conflict as they try to help Mali's weak army counter bombings and raids.

"There was an infiltration by Islamists overnight and there is shooting all over the place," Sadou Harouna Diallo, Gao's mayor, told Reuters by telephone, saying he was not in his office at the time.

Gao is a French hub for operations in the Kidal region, about 300 km (190 miles) northeast, where many Islamist leaders are thought to have retreated and foreign hostages may be held.

A Malian soldier in Gao who gave his name only as Sergeant Assak told Reuters he had seen at least seven Islamist gunmen.

"They are black and two were disguised as women," he said during a pause in heavy gunfire around Independence Square.

Six Malian military pickups were deployed in the square and opened fire on the mayor's office with the heavy machineguns. Two injured soldiers were taken away in an ambulance.

French troops in armored vehicles later joined the battle as it spilled out into the warren of sandy streets, where, two weeks ago, they also fought for hours against Islamists who had infiltrated the town via the nearby river.

Helicopters clattered over the mayor's office, while a nearby local government office and petrol station was on fire.

A Gao resident said he heard an explosion and then saw a Malian military vehicle on fire in a nearby street.

Paris has said it plans to start withdrawing some of its 4,000 troops from Mali next month but the rebel fightback comes as Mali's army remains weak and divided and African forces due to take over the French role are not yet in place.

Islamists abandoned the main towns they held but French and Malian forces have said there are pockets of Islamist resistance across the north, which is about the size of France.

CAR BOMB

Residents reported a bomb in the east of Kidal on Thursday.

"It was a car bomb that exploded in a garage," said one resident who went to the scene but asked not to be named.

"The driver and another man were killed. Two other people were injured," he added.

A French defense ministry official confirmed there had been a car bomb but said it did not appear that French troops, based at the town's airport, had been targeted.

Earlier this week, a French soldier was killed in heavy fighting north of Kidal, where French and Chadian troops are hunting Islamists in the Adrar des Ifoghas mountains, which border Algeria.

Operations there are further complicated by the presence of separatist Tuareg rebels, whose rebellion last year kick-started fighting in northern Mali but were sidelined by the better-armed Islamists.

Having dispatched its forces to prevent an Islamist advance south in January, Paris is eager not to become bogged down in a long-term conflict in Mali. But their Malian and African allies have urged French troops not to pull out too soon.

(Additional reporting by Emanuel Braun in Gao, Adama Diarra in Bamako, David Lewis and John Irish in Dakar; Writing by David Lewis; Editing by Jason Webb)

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Nigerian troops surround French family's kidnappers: source

YAOUNDE/MAIDUGURI, Nigeria (Reuters) - Nigerian security forces surrounded the kidnappers of a French family in northeast Borno state on Thursday in an operation to rescue the hostages, a Nigerian military source said.

French, Nigerian and Cameroonian officials earlier denied French media reports that the family, who were seized in Cameroon and taken over the border, had been freed.

The Nigerian military located the hostages and kidnappers between Dikwa and Ngala in the far northeast, the military source in Borno said, asking not to be identified.

Dikwa is less than 80 km (50 miles) from the border with Cameroon where the three adults and four children were taken hostage on Tuesday.

A senior Cameroonian military official declined to comment saying the matter was too sensitive.

Citing a Cameroon army officer, French media reported earlier on Thursday that the hostages had been found alive in a house in northern Nigeria.

"This is a crazy rumor that we cannot confirm. We do not know where is it coming from," Cameroon Communications Minister Issa Tchiroma Bakary told Reuters by telephone from the capital Yaounde.

"What is certain is that the French tourists who were abducted are no longer on our territory. However, we are in touch with the Government of Nigeria to intensify measures to continue the search for them along our common border," he said.

French gendarmes backed by special forces arrived in northern Cameroon on Wednesday to help locate the family, a local governor and French defense ministry official said.

Nigerian military spokesman Sagir Musa earlier also said the report on France's BFM television of the hostages being released was "not true," while Didier Le Bret, the head of the French foreign ministry's crisis center, said the information was "baseless."

The abduction was the first case of foreigners being seized in the mostly Muslim north of Cameroon, a former French colony.

But the region - like others in West and North Africa with porous borders - is considered within the operational sphere of Boko Haram and fellow Nigerian Islamist militants Ansaru.

On Sunday, seven foreigners were snatched from the compound of Lebanese construction company Setraco in northern Nigeria's Bauchi state, and Ansaru took responsibility.

Northern Nigeria is increasingly afflicted by attacks and kidnappings by Islamist militants. Ansaru, which rose to prominence only in recent months, has claimed the abduction in December of a French national who is still missing.

Three foreigners were killed in two failed rescue attempts last year after being kidnapped in northern Nigeria and Ansaru, blamed for those kidnaps, warned this could happen again.

The threat to French nationals in the region has grown since France deployed thousands of troops to Mali to oust al Qaeda-linked Islamists who controlled the country's north.

The kidnapping in Cameroon brought to 15 the number of French citizens being held in West Africa.

(Reporting By Emile Picy and Nicholas Vinocur in Paris; Additional reporting by Joe Brock in Abuja and Bate Felix and John Irish in Dakar; Writing by Bate Felix and John Irish; Editing by Angus MacSwan)

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Lawmakers target ECB to stop Iran from using euros

WASHINGTON/FRANKFURT (Reuters) - Lawmakers are crafting a bill aimed at stopping the European Central Bank from handling business from the Iranian government, a congressional aide said on Thursday, an attempt to stop Tehran from using euros to develop its nuclear program.

The bill, in the early stages of drafting, would target the ECB's cross-border payment system and impose U.S. economic penalties on entities that use the European Central Bank to do business with Iran's government, the aide said on condition of anonymity.

The central bank's so-called Target2 system is used to settle cross-border payments in Europe and processes around 350,000 payments daily, according to the most recent figures made available.

Although the ECB already complies with European Union sanctions against Iran, the proposed bill is aimed at pressing Europe to do more to prevent Iranian firms and banks from using the Target2 system to conduct transactions involving euros.

"The ECB ensures that no illegitimate transactions are cleared in Target2," a spokesman for the euro zone's central bank said. "But any sanctions are EU sanctions and not an ECB competence."

The ECB provision is part of a wider U.S. bill aimed at choking off funds to the Iranian government, which the West accuses of developing nuclear weapons. Tehran denies the charges.

It is unclear when the bill would be introduced or whether there would eventually be support in the U.S. Congress or by the Obama administration to enact another set of economic sanctions.

The United States and the European Union have worked mostly in tandem in imposing harsh economic sanctions against Iran, which have so far slashed the country's oil revenues, disrupted trade and weakened its currency.

ECB representatives are due in Brussels at the start of March for working discussions on various Iran sanctions issues, EU sources said, though the meetings were not specifically to discuss Target2.

Last year, U.S. lawmakers were successful in pressuring Belgium-based SWIFT electronic payment system to block Iranian transactions. SWIFT, which facilitates the bulk of global cross-border payments, disconnected designated Iranian financial firms from its messaging system after European regulators ordered the company to do so.

(Reporting by Paul Carrel in Frankfurt, Justyna Pawlak in Brussels and Rachelle Younglai in Washington. Editing by Jeremy Gaunt.)

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Bomb blasts rock southern Indian city; at least 11 dead

HYDERABAD, India (Reuters) - Two bombs placed on bicycles exploded in a crowded market-place in the southern Indian city of Hyderabad on Thursday, and the federal home minister said at least 11 people were killed and 50 wounded.

All major cities in the country were placed on high alert, television channels said, adding that as many as 15 people may have been killed in the explosions.

Hyderabad is a major IT center in India, only second to Bangalore. Microsoft and Google have major centers in the city.

"Both blasts took place within a radius of 150 meters," federal Home (Interior) Minister Sushil Shinde told reporters, adding the explosives were placed on bicycles parked in the crowded marketplace. "Eight people died at one place, three at the other."

The explosions come less than two weeks after India hanged a Kashmiri man for a militant attack on the country's parliament in 2001 that had sparked violent clashes.

Witnesses told Reuters they heard at least two explosions in the Dilsukh Nagar area of Hyderabad just after dusk but there could have been more.

TV showed debris and body parts strewn on the street in the area, a crowded neighborhood of cinema halls, shops, restaurants and a fruit and vegetable market.

Prime Minister Manmohan Singh called it a "dastardly attack".

"I appeal to the public to remain calm and maintain peace," he said in a Twitter message.

In July 2011, three near-simultaneous blasts ripped through India's financial capital, Mumbai. At least 20 people were killed and over 100 wounded in the blasts set off by Muslim militants, authorities said.

Last year, four small explosions occurred in quick succession in a busy shopping area of the western Indian city of Pune.

(Reporting by Devidutta Tripathy, Mayank Bhardwaj and Satarupa Bhattacharjya; Editing by Raju Gopalakrishnan and Jeremy Laurence)

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Bulgaria faces deadlock after government quits

SOFIA (Reuters) - Bulgaria's parliament on Thursday accepted the government's decision to resign in the face of anti-austerity protests, opening the way for an early election that may benefit fringe parties and make it hard to form a stable government.

Outgoing Prime Minister Boiko Borisov, praised by investors for cutting the budget deficit, lost support from voters in the European Union's poorest state over his failure to raise living standards or stamp out graft.

After mass protests set off by high energy bills, Borisov stepped down on Wednesday -- the latest administration to fall in Europe's four-year-old debt crisis.

Parliament voted on Thursday to accept the move and President Rosen Plevneliev will now ask the three biggest parties if they want to form a government to rule until a parliamentary election due in July.

But both Borisov's GERB party and the main opposition Socialists have said they do not want to participate in a caretaker cabinet, so Plevneliev could schedule an election for as early as April. Opinions polls put both parties on about 22-23 percent, suggesting no clear majority in the new parliament.

"We are open for dialogue with all parties but GERB, who ruined everything," said Socialist leader Sergei Stanishev, whose party was level in polls with Borisov's before the protests and may have benefited from the unrest.

The cabinet's departure brought some calm after a chaotic week of rallies against the government and foreign-owned power utilities and a threat by Bulgarian officials to strip one of them, Czech power group CEZ, of its license.

Boriana Dimitrova, an analyst with pollster Alpha Research, said it could push voters towards the political fringe.

"The two key political powers are not strong enough to form a stable government," she said. "The recent protests indicate there is growing support for radical, populist parties, which will also make it harder to form a cabinet."

CALM, FOR NOW

Borisov, a former guard to Soviet-era dictator Todor Zhivkov, won adoration from voters by building highways and improving roads so badly pot-holed that cars could lose wheels and travel across the small country could take up most of a day.

Around 2,000 Bulgarians waving GERB party flags, including farmers driving tractors and a truck full of pigs, cheered in front of parliament in support of Borisov.

"If all possibilities are exhausted...I will form an interim government, quickly and responsibly," said Plevneliev.

Borisov's administration also impressed foreign portfolio investors by freezing wages and pensions and cracking down on the grey economy by digitally linking firms ranging from the largest factory to the smallest kiosk to the tax office.

But those moves angered many in the Black Sea state of 7.3 million, who are also frustrated at his failure to make good on his 2009 election pledge to stamp out endemic corruption and reform inefficient healthcare and education systems.

"Am I pleased with Borisov's resignation? He's just the same as the ones before. They're all corrupt and they don't care about people," said Filip Ivanov, a 37-year-old taxi driver.

Borisov's popularity has suffered due to growing frustration over the slow plod from poverty of a country which has failed to grow convincingly since recession hit in 2009. Living standards are about 45 percent of the EU average, the bloc's lowest.

For many here, where wages average about 400 euros a month and pensions about half that, the final straw was winter power bills which at times exceeded incomes due to price rises that began to bite as temperatures fell.

In protests this month, tens of thousands blocked roads and some clashed with police and attacked offices of power distributors CEZ, Czech Energo Pro and Austrian EVN. The utilities say the increase was in line with a government approved hike in prices last year and said they had done nothing wrong.

Borisov's threat to strip CEZ of its power distribution license has also put Sofia at odds with fellow European Union member the Czech Republic and raised eyebrows over its adherence to the bloc's stipulation that its members follow due process.

But Bulgaria's power regulator appeared to soften its stance slightly on Wednesday, saying CEZ may be able to keep its license if it reverses violations of the public procurement law. CEZ shares fell 2.8 percent on Thursday to a four-year low and Prague urged the European Union to step in.

Before stepping down, Borisov tried to appease voters by sacking Finance Minister Simeon Djankov, a lightning rod for criticism for his leading the charge on belt tightening, and promising a cut in power bills as of March.

For their part, the Socialists have pledged to raise taxes on the rich and scrap a flat 10 percent income tax rate it introduced in 2009 They also want to raise the minimum wage, restart the Russian-backed Belene nuclear power project and to impose strict control on utilities and fight monopolies. that has been a draw for foreign investors.

(Editing by Philippa Fletcher)

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Car bomb kills over 50 near Damascus ruling party office

BEIRUT (Reuters) - A car bomb killed more than 50 people and wounded 200 in central Damascus on Thursday when it blew up on a busy highway close to ruling Baath Party offices and the Russian Embassy, state media and activists said.

Syrian television showed charred and bloodied bodies strewn across the street after the blast, which it described as a suicide bombing by "terrorists" battling President Bashar al-Assad. It said 53 people were killed.

Central Damascus has been relatively insulated from almost two years of unrest and civil war in which around 70,000 people have been killed across the country, but the bloodshed has shattered suburbs around the capital.

Rebels who control districts to the south and east of Damascus have attacked Assad's power base for nearly a month and struck with devastating bombs over the last year.

The al Qaeda-linked rebel group Jabhat al-Nusra, which claimed responsibility for several of those bombs, says it carried out 17 attacks around Damascus in the first half of February, including at least seven bombings.

Activists said most of the victims of Thursday's attack in the city's Mazraa district were civilians, including children, possibly from a school behind the Baath building.

Opposition activists reported further explosions elsewhere in the city after the explosion which struck shortly before 11 a.m. (0900 GMT).

One resident in the heart of the capital heard three or four projectiles whistling through the sky, followed by explosions. At least one of them landed in a public garden in the Abu Rummaneh district, she said, but no one was hurt.

EMBASSY DAMAGED

The Britain-based Syrian Observatory for Human Rights, which monitors violence via a network of sources inside Syria, said the Mazraa car bomb was detonated at a checkpoint close to the Baath Party building, located about 200 meters (660 feet) from the Russian embassy.

It said 56 people were killed, of which at least 15 were from Syria's security forces and the rest civilians. Eight other people were killed by a car bomb in the Barzeh district of northeast Damascus, one of several explosions which followed the Mazraa attack.

Russia's Itar-Tass news agency quoted a diplomat as saying the Mazraa blast blew out windows at the Russian Embassy, but no employees were wounded. "The building has really been damaged ... The windows are shattered," the diplomat said.

The vehicle was carrying between 1 and 1.5 metric tons (1.65 tons) of explosives, Damascus Governor Bishr Sabban told Reuters.

A correspondent for Syrian television said he saw seven body bags with corpses at the scene. He counted 17 burnt-out cars and another 40 that were destroyed or badly damaged by the force of the blast, which ripped a crater 1.5 meters deep into the road.

Syrian TV said security forces had detained a would-be suicide bomber with five bombs in his car, one of them weighing 300 kg (440 pounds).

In the southern city of Deraa, where the uprising against Assad erupted in March 2011, warplanes bombed the city's old district for the first time in nearly two years of conflict, killing 18 people, activists said.

A rebel officer in the Tawheed al-Janoub brigade which led a rebel offensive this week in Deraa said there were at least five air strikes on the city on Thursday.

"The (rebel) attacks on several major checkpoints in the Hay al-Saad neighborhood and its declaration as a liberated area have prompted this response," said Abdullah Masalmah, an activist from the city, via Skype.

Fighting has intensified in southern Syria in recent weeks, leading to a sharp increase in refugee flows to neighboring Jordan, according to officials. A Jordanian military source said 4,288 refugees arrived in the last 24 hours alone.

Nayef Hawatmeh, head of the Damascus-based Democratic Front for the Liberation of Palestine, was lightly wounded by an explosion in a mosque next to his office, a DFLP official said.

Talal Abu Tharifa told Reuters in Gaza that glass fragments had caused a slight wound to Hawatmeh's hand.

(Additional reporting by Marwan Makdesi in Damascus, Laila Bassam and Mariam Karouny in Beirut, Suleiman al-Khalidi in Amman, Nidal al-Mughrabi in Gaza and Alissa de Carbonnel in Moscow; Editing by Andrew Roche)

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Italy election stalemate worst option for markets

LONDON (Reuters) - An inconclusive result in Italy's elections this weekend could prompt an even bigger sell-off in some markets than the return to power of scandal-mired Silvio Berlusconi, who led the country to the financial precipice in 2011.

Italian stocks, bonds and, to a lesser extent, the euro are all expected to rise if, as the latest polls suggest, the centre-left led by Pier Luigi Bersani wins a majority in the lower house and forms a stable pact in the Senate with outgoing centrist Prime Minister Mario Monti to head a reform-minded government.

But prices will fall if Italy, whose mountainous debts catapulted it to the forefront of the euro zone debt crisis under Berlusconi 15 months ago, emerges from the February 24-25 election with a hung parliament incapable of producing a stable administration, analysts say.

Italian debt and shares sold off sharply in recent weeks as Berlusconi made big gains in opinion polls. However, with his centre-right party lagging the centre-left by 4-5 points in the final polls before a pre-election blackout, markets have largely discounted the return to power of the media tycoon, who has been weakened by a string of sex and financial scandals.

"I am inclined to think the centre-left and centre will have control, but the marketplace as a whole is reasonably complacent about the risk we do not get that outcome," said UBS currency strategist Geoffrey Yu.

On the surface, markets appear calm just two days before voting. Italian stocks had regained half their 4 percent political risk-driven fall by Wednesday, and 10-year bond yields were off their recent highs.

Italy's blue-chip stock index, the FTSE MIB, having started 2013 strongly, is nursing losses for the year and lagging the pan-European Euro STOXX 50 and national indexes in France, Germany and Britain.

Antonin Jullier, global head of equity trading at Citi said a centre-left/Monti win could push shares higher.

"There is another 2 percent to grab in both the E-STOXX 50 and the FTSE-MIB if the result goes for Bersani-Monti," he said.

Aviva Investors reckon the gain under such a scenario could be as much as 5 percent, with the most market-neutral event being an outright Bersani win and the worst not a Berlusconi victory, which could prompt a 2 percent fall, but a hung parliament, which could see stocks fall 5 percent.

That fear has driven the cost of protection against a fall in the FTSE MIB to its most expensive since mid-September.

BOND YIELDS

Italy's borrowing costs have fallen sharply since Monti formed his technocrat administration in November 2011. This is in large part due to last year's pledge by European Central Bank President Mario Draghi to do "whatever it takes" to save the euro and subsequent offer to buy the bonds of struggling euro zone countries that seek help - the so-called 'Draghi put'.

"Our perception is that the Draghi put is working, and this has changed the game to the benefit of peripherals," Commerzbank fixed income strategist Michael Leister said.

But there's a lot of paddling beneath the calm surface, with volumes in Italian bond futures at their highest four-week moving average since the contract was launched in 2009, a Reuters analysis shows. That means there are still plenty of investors bailing out of Italian bonds, while others, reassured by the ECB's back-stop, have been snapping them up.

A hung parliament would see yields, which move inversely to prices, jump, with a knock-on effect in the rest of the euro zone periphery, especially in Spain.

William de Vijlder, chief investment officer of BNP Paribas Investment Partners, said a stable reformist government could see 10-year yields fall towards 4 percent from levels around 4.9 percent, while stalemate could push them up towards 5.2 percent.

Louis Gargour, CIO of hedge fund firm LNG Capital, said a Berlusconi win could push Italian yields up 75-100 basis points.

Even that would leave yields below the unsustainable levels above 7 percent hit in late 2011.

Hedge funds were also betting on an expected rise in volatility in the euro's exchange rate against the dollar early next week, a chief options trader at a large European bank said.

"People are definitely heading into the election a bit more cautious. There was a lot more selling last week and a defensive stance," UBS's Yu said, adding a shaky coalition could see the euro fall to $1.30 from current levels around $1.32.

Dagmar Dvorak, director of currency and fixed income at Barings Asset Management, said the fund was underweight the euro before the election.

She also said the euro could fall to $1.30, but expected more reaction in bond markets as the single currency was supported by the ECB's policy stance.

"I don't expect a sharp move down in the euro. It is still supported by (the ECB's) balance sheet contraction versus expansion elsewhere."

(This story corrects surname in 17th paragraph to read Gargour)

(Additional reporting by Anirban Nag, Nia Williams, Emelia Sithole-Matarise, Toni Vorobyova, David Brett, Laurence Fletcher, Alistair Smout, Marius Zaharia, Sudip Kar Gupta, William James, Francesco Canepa and Annika Breidthardt; editing by Nigel Stephenson and Will Waterman)

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Iran installs advanced enrichment centrifuges: IAEA

VIENNA (Reuters) - Iran has begun installing advanced centrifuges at its main uranium enrichment plant, a U.N. nuclear report said on Thursday, a defiant step likely to anger world powers ahead of a resumption of talks with Tehran next week.

In a confidential report, the International Atomic Energy Agency (IAEA) said 180 so-called IR-2m centrifuges and empty centrifuge casings had been hooked up at the plant near the central town of Natanz.

If operated successfully, such machines could enable Iran to significantly speed up its accumulation of material that the West fears could be used to devise a nuclear weapon. Iran says it is refining uranium only for peaceful energy purposes.

The report also said Iran had increased to 167 kg (367 pounds) its stockpile of uranium refined to a fissile purity of 20 percent - a level it says it needs for conversion into reactor fuel. About 240-250 kg of 20 percent enriched uranium is needed for one atomic bomb if refined to a high degree.

Iran resumed converting higher-grade enriched uranium for fuel production in December and had since fed 28.3 kg of the material for this stated purpose, the report added.

It further said that "extensive" activities - an allusion to clean-up and renovations - at Iran's Parchin military site would seriously undermine an IAEA investigation to determine whether explosives research relevant to nuclear weapons was done there.

(Reporting by Fredrik Dahl; Editing by Mark Heinrich)

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Tunisia's Islamist Ennahda to pick hardliner for PM

TUNIS (Reuters) - Tunisia's main Islamist Ennahda party will pick a hardliner to replace moderate outgoing Prime Minister Hamadi Jebali after he declined to head the next government, a party official said on Thursday.

Jebali, who is secretary-general of Ennahda, resigned on Tuesday after his plan for an apolitical technocrat cabinet to prepare for elections collapsed, largely because of opposition from within his own party and its leader, Rached Ghannouchi.

"Jebali declined to accept nomination (for next prime minister)," Ennahda said. "A new candidate will be presented to the president of the republic this week."

The assassination of opposition leader Chokri Belaid on February 6 plunged Tunisia into its worst political crisis in the two years since a revolt toppled President Zine al-Abidine Ben Ali and inspired Arabs elsewhere to rebel against autocratic rulers.

The secular leftist's killing sent protesters flooding into the streets, exposing the deep rifts between Tunisia's empowered Islamists and their liberal and secular-minded opponents.

Jebali had proposed forming technocrat cabinet to replace his Ennahda-led coalition, which included two secular parties, to spare the North African nation's nascent democracy and its struggling tourism-dependent economy from further strife.

But Ghannouchi blocked the moderate premier's plan and a senior Ennahda official told Reuters that the next prime minister would come from the party's hardline wing, which opposes any role for politicians linked with the Ben Ali era.

The official listed outgoing Justice Minister Nourredine Bouheiri, Health Minister Abdellatif Mekki, Agriculture Minister Mohammed Ben Salem, Interior Minister Ali Larayedh and Transport Minister Abdelkarim Harouni as the possible nominees.

"Ennahda will hold a meeting tonight to choose a candidate. The next prime minister will be one of the names on this list," said the official, who asked not to be named.

SECULAR PARTNER

Ennahda won Tunisia's first free election in October 2011 and controls 89 seats in the 217-member National Constituent Assembly assigned the task of drafting a new constitution.

Tunisian secular president, Moncef Marzouki, will ask the next prime minister to form his government within two weeks.

Ghannouchi has previously said it is vital that Islamists and secular parties share power now and in the future, and that his party was willing to compromise over control of important ministries such as foreign affairs, justice and interior.

Marzouki's secular Congress for the Republic party (CPR), which has 29 assembly seats and was part of Jebali's coalition, said on Thursday it was ready to join the next one.

"Our party will take part in the new government and will have an active role to play," the CPR's spokesman, Hedi Ben Abbes, said after a meeting with Marzouki.

Together, Ennahda and CPR would have 118 seats, wielding a majority in the assembly. It is not clear whether other secular parties would join such a coalition, particularly in the charged political atmosphere following Belaid's assassination.

Ennahda's own unity might also come under strain following the very public differences that have emerged between Ghannouchi and Jebali, who served as prime minister for 14 months.

Tunisia began a transition to democracy after Ben Ali's peaceful overthrow in January 2011, holding elections for the National Constituent Assembly and then forging a deal under which Ennahda agreed to share power with its secular rivals.

But disputes have delayed the constitution, and grievances over unemployment and poverty have led to frequent unrest.

"Today I cannot send a message of reassurance to investors abroad because local investors in Tunisia are not reassured and the outlook is not entirely clear," Wided Bouchamaoui, president of the Chambers of Commerce and Industry, said on Wednesday.

Negotiations on a $1.78 billion loan from the International Monetary Fund cannot be concluded amid the latest uncertainty.

Standard and Poor's lowered its long-term foreign and local currency sovereign credit rating on Tunisia on Tuesday, citing "a risk that the political situation could deteriorate further amid a worsening fiscal, external and economic outlook".

(Reporting By Tarek Amara; Editing by Alistair Lyon)

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NATO urges allies to reverse defense spending cuts

BRUSSELS (Reuters) - NATO chief Anders Fogh Rasmussen urged allies on Thursday to reverse damaging defense-spending cuts once their economies improve as U.S. officials warned of the impact that across-the-board U.S. budget reductions could have on the alliance.

"If defense cuts continue, it will have a negative impact on our ability to provide effective defense and protection of our populations," Rasmussen told reporters at the start of a NATO defense ministers' meeting.

He appealed to allies, many of which have slashed defense spending in response to the economic crisis, to stop defense cuts, use their resources more efficiently by working together, and to increase defense spending once their economies recover.

He declined to comment directly on $46 billion in U.S. budget cuts scheduled to take effect from March 1 that would slash nearly every U.S. military program or activity by a flat percentage unless Congress acts to avert them.

"But from an overall perspective it is of course a matter of concern that we have seen and continue to see declining defense budgets all over the alliance," Rasmussen said.

U.S. Defense Secretary Leon Panetta intends to warn NATO allies in Brussels that cuts under the "sequester" - as the mechanism for the across-the-board cuts is known - could impact U.S. contributions to NATO readiness, Pentagon spokesman George Little said.

"We think the alliance's readiness could be diminished if sequestration takes effect," he told reporters during Panetta's flight to Brussels on Wednesday.

In talks with his Italian counterpart in Brussels on Thursday, Panetta warned "how devastating sequestration would be for U.S. defense and national security", Little said.

While the Obama administration is pushing lawmakers to avert sequestration, Panetta formally notified Congress on Wednesday that the Pentagon plans to put civilian defense employees on unpaid leave this year if the cuts go ahead.

LION'S SHARE

President Barack Obama signed the Budget Control Act in 2011 requiring $487 billion in defense spending cuts over a decade. The law also put in place another $500 billion in mandatory, across-the-board Pentagon cuts.

The cuts were never meant to go into effect, but were intended to coerce Congress and the White House into agreeing on more selective budget reductions. That deal never happened.

The United States, which provides the lion's share of NATO's firepower, has been urging European allies for years to pick up more of the defense burden.

Washington has pressed European countries to take the lead in operations like the 2011 Libya campaign but the Europeans still need U.S. help with key capabilities like air-to-air refueling and intelligence.

The threat of U.S. cuts could give Washington another argument to press European allies to increase defense spending by showing the danger of over-reliance on the United States.

Only a handful of NATO's 28 allies - the United States, Britain and Greece - last year spent more on defense than the two percent of Gross Domestic Product target set by NATO.

Britain, which has cut defense spending to rein in a big budget deficit, also urged allies to commit to increase defense spending once their economies improved.

"I don't hear that commitment as clearly as I would like to hear it (from European allies)," British Defense Secretary Philip Hammond told reporters before the Brussels meeting, which is focusing on Afghanistan and improving NATO's capabilities.

British Prime Minister David Cameron raised the possibility on Thursday of diverting hundreds of millions of pounds from foreign aid to defense and security.

(Additional reporting by Robert-Jan Bartunek, Francesco Guarascio, Erik Matzen; Editing by Michael Roddy)

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