ROME (Reuters) - Italy anxiously awaits the reaction of financial markets Monday to the appointment of former European Commissioner Mario Monti to head a technocratic government, hoping it will end a disastrous week for the Eurozone's third largest economy.

In a frenetic weekend of political activity, Italy's parliament approved a package of economic reforms agreed with European leaders, Prime Minister Silvio Berlusconi resigned and President Giorgio Napolitano appointed Monti, a respected international figure as head of a new government.

The whole hurried process, much faster than is normal, was designed to calm markets, which last week pushed Italy's borrowing costs to the levels that forced Portugal, Greece and Ireland to seek bailouts.

The first test will come Monday when the Treasury offers up to 3 billion euros worth of 5-year BTP bonds in an auction that will show how far fragile confidence in Italy's battered public finances has been restored.

Because the Eurozone cannot afford the much bigger bailout that would be needed to save its third largest economy, the crisis threatened a European financial meltdown.

Napolitano said after nominating Monti that there must be an extraordinary effort to address the crisis and Italy could not wait for elections to solve political paralysis. He said Italy must recover the trust of investors and European institutions.

Monti said he would work urgently to form a government and to pull Italy out of the crisis. The new government is thought likely to be a tight cabinet of around 12 technocrats and to be appointed within days.

I intend to fulfil this task with a great sense of responsibility in the service of our country. In a moment of particular difficulty for Italy, in a turbulent situation for Europe and the world, the country needs to meet the challenge, Monti said after his nomination. 

UNPOPULAR MEASURES

Italy's borrowing costs soared to way above a red line of 7 percent last week but markets calmed once it became clear that Berlusconi would go and Monti take his place.

Berlusconi went on television Sunday and said he had resigned out of a sense of responsibility and to protect Italy from speculators. He expressed sadness that thousands of protesters yelling insults including clown had jeered him when he went to Napolitano's palace to hand in his resignation.

Monti's government will try to push through reforms agreed by Berlusconi with Eurozone leaders to cut Italy's massive debt and revive a chronically stagnant economy. But he could face opposition from right and left to some of the more unpopular measures on pensions and the labor market.

There are clear signs that he will face problems, with Angelino Alfano, secretary of Berlusconi's PDL party, saying there was huge opposition among its members despite promising its support to the new prime minister.

The devolutionist Northern League, Berlusconi's partner in the center-right coalition, also said Monti would face an uphill battle in getting parliamentary support for the reforms from a disparate group of parties supporting the technocratic government.

Italy's political turmoil was very much centred around the flamboyant and scandal-plagued figure of Berlusconi, and thousands of demonstrators partied in the streets of Rome on Saturday after he resigned.

The normally ebullient media magnate cut a forlorn figure as he stared from his car, looking pale and drawn, when he left Napolitano's palace.

Top European Union officials and German Chancellor Angela Merkel welcomed signs of an end to the weeks of uncertainty, with Merkel saying the approval of a reform package in parliament Saturday was heartening.  

I hope that confidence in Italy is restored, which is crucial for a return to calm throughout the Eurozone, she said ahead of a party conference in Leipzig.

Berlusconi, one of Italy's richest men, had dominated the country since bursting onto the political scene in 1994.

The next election is not due until 2013 but there are widespread predictions Monti will not last until then, making way for polls once he passes the reforms promised to Europe.

(Additional reporting by Roberto Landucci, Massimiliano Di Giorgio, Paolo Biondi, James Mackenzie and Philip Pullella; Editing by Janet Lawrence)