* Bank of Italy chief warns Italy "must not lower its guard"
* Concern grows over uncertain election, pace of reform
* Industry body says consumption drop "worst in 50 years"
By James Mackenzie
ROME, Feb 9 Financial markets remain keenly focused on Italy's ability to control its public finances and pursue reforms to lift its stagnant economy, European Central Bank governing council member Ignazio Visco said on Saturday.
Confidence in Italy has been shaken in the run-up to elections, after a strong campaign by former Prime Minister Silvio Berlusconi that has opened up the race and threatened the prospects of stable government emerging after the vote.
"Italy must not lower its guard," Visco, the governor of the Bank of Italy, said according to the text of a speech at a conference in Bergamo.
"The attention of international investors continues to focus, rightly, on our capacity to preserve balance in public finances and to pursue with determination, an increase in our development potential," he said.
He said periodic bouts of market tension, which have been seen over the past few weeks as elections on Feb 24-25 approach, underlined the fragility of Italy's economy, which the Bank of Italy forecasts will shrink by 1 percent this year.
The main gauge of market sentiment towards Italy, the difference or spread between yields on 10 year BTP bonds and safer German Bunds has widened in recent days and briefly topped 300 basis points on Friday, up from 280 points a month ago.
European Economic and Monetary Affairs Commissioner Olli Rehn echoed the concern that the election could halt the course of reform in the euro zone's third-largest economy, which is stuck in recession with a public debt burden second only to Greece in the 17-member bloc.
"It's a very fragile situation. Whatever colour the new government in Italy has, it is important that it maintains the course of reform," he told an Austrian magazine in an interview published on Saturday.
The comments, as the election countdown begins, underline concern about the vote, which pits former prime ministers Silvio Berlusconi and Mario Monti in an uncertain three-way race for power against centre-left leader Pier Luigi Bersani.
The agenda is dominated by the slack state of the Italian economy, which is suffering from record unemployment and a recession that has been deepened by almost two years of repeated tax hikes and spending cuts.
On Saturday, retail industry association Confcommercio said consumption in Italy had fallen 4 percent last year, which it said was the biggest fall in 50 years.
Bersani is leading in the opinion polls but Berlusconi's campaign has cut into his advantage and threatened to force the centre-left and Monti to seek a potentially unstable coalition deal after the election.
The anti-establishment 5-Star Movement led by fiery comic Beppe Grillo, who rejects any alliance with the mainstream parties, is also expected to take a large share of the vote, adding an additional uncertainty factor.
Visco repeated the Bank of Italy's forecast that the economy should start to recover in the second half of the year but said it was vital that the next government continue on the reform path laid out with its European partners.
He said it would have to focus on improving productivity, strengthening investment and improving the efficiency of public services but he also singled out the high overall tax burden as a crucial factor weighing down the economy.
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