UPDATE 1-Italy's 5-Star unsettles PD with tough terms for coalition deal
* Italian PM Conte holding talks on new govt
* PD seek answers over 5-Star's uncompromising stance
* Markets fall as 5-Star warns of possible election (Adds further reaction to 5-Star, markets falling)
By Angelo Amante and Crispian Balmer
ROME, Aug 30 (Reuters) - Italy's 5-Star Movement will enter a coalition with the opposition Democratic Party (PD) only if it agrees to a string of policy demands, the 5-Star leader said on Friday, setting an uncompromising tone for the negotiations.
Luigi Di Maio's hardline message dented growing optimism that a deal might be at hand, causing financial markets to fall, while a stunned PD sought immediate clarification that 5-Star still wanted an accord.
The previous coalition made up of 5-Star and the far-right League collapsed earlier this month when League leader Matteo Salvini withdrew from the alliance hoping to trigger an early election and cash in on his surging popularity.
Salvini's move backfired when 5-Star and the PD unexpectedly said they would be willing to try to lay aside old animosities and forge a new coalition, with Prime Minister Giuseppe Conte, who is not a member of any party, remaining at the helm.
However, Di Maio struck a seemingly intransigent line following an initial round of talks with Conte, saying the PD would have to back an array of policies if it wanted to govern, including measures the group has already denounced.
"Our programme points are clear. If they are included in the government programme, then we can start. If not, it would be better to go back to elections, and, I might add, as soon as possible," a stony faced Di Maio told reporters.
Amongst the measures he mentioned were a drive to cut the number of parliamentarians, the revocation of the motorway concession of Italian firm Atlantia and the acceptance of a recent law aimed at clamping down on migrant sea rescues.
The 5-Star later issued its 20-point programme, which adopted more flexible language than that used by Di Maio, and made no mention of the migrant law, which was drawn up by Salvini and is an especial anathema to Italy's leftists.
A party source said the tougher line from Di Maio was a message to 5-Star's grassroots that it was not selling out its principles. Some senior 5-Star figures are wary of any pact with the PD, fearing that it could erode the anti-establishment credentials of a party already losing support.
MARKETS WEAKEN
Di Maio also accused the PD of focusing too much on the names of possible ministers, and both the tough tone and inflexible content of his statement shocked the PD leadership.
"Incomprehensible. ... Have you changed your mind?" PD deputy leader Andrea Orlando wrote on Twitter. PD lawmaker Maria Elena Boschi said: "These threats and ultimatums from Di Maio are unacceptable".
After a week of solid gains on the back of hopes that Italy was going to avoid early elections, financial markets lost ground on Friday afternoon following Di Maio's comments.
The bluechip Mib30 stocks index fell into negative territory, shedding 0.3 percent by 1430 GMT, while the spread between benchmark Italian and German 10-year bonds rose 12 basis points from their earlier lows.
A 5-Star/PD tie up was seen as likely to bring some political stability to Italy and soothe Rome's fractious ties with the European Union following a series of spats over public spending orchestrated in part by the eurosceptic League.
If the talks between 5-Star and PD fall apart even before a government can take office, President Sergio Mattarella will have to call elections some 3-1/2 years ahead of schedule.
A opinion poll published in La Stampa daily on Friday showed that although support for League had fallen as a result of the political turmoil, it remains Italy's most popular party with backing of 32% against 36% a month ago.
The PD had edged higher to 23.5% from a previous 22.5% while 5-Star was seen on 16.5 from 17.5%.
(Additional reporting by Gavin Jones and Giselda Vagnoni Writing by Crispian Balmer Editing by Jon Boyle and Peter Graff)
