* 5-Star, PD expected to seal a deal on govt led by Conte
* Conte headed the previous 5-Star/League coalition
* 5-Star online referendum could sink the proposed pact
* Markets rally on hopes of new government
By Giselda Vagnoni and Angelo Amante
ROME, Aug 29 (Reuters) - Italy’s head of state is expected to give two former political enemies the chance to form a new government on Thursday, capping an extraordinary three weeks that could mark a turning point in its frayed relations with the European Union.
President Sergio Mattarella meets Prime Minister Giuseppe Conte at 9.30 a.m. (0730 GMT) on Thursday, and is expected to hand him a fresh mandate to put together a new coalition of the 5-Star Movement and opposition Democratic Party (PD).
Sworn enemies in the past, the two parties entered coalition talks after 5-Star’s former coalition partner, the right-wing League party led by eurosceptic Matteo Salvini, declared the government unworkable and called for snap elections.
Salvini’s move backfired and on Wednesday night, the anti-establishment 5-Star party and centre-left PD announced they would try to form a coalition under the continued leadership of Conte, a technocrat who is seen as close to 5-Star.
The two sides still need to agree on a shared policy platform and team of ministers, but 5-Star chief Luigi Di Maio and his PD counterpart Nicola Zingaretti said they had pledged to find common ground for the good of the country.
“We love Italy and we consider it worthwhile to try this experience,” Zingaretti told reporters. Speaking shortly afterwards, Di Maio said: “We made commitments to the Italians...and come what may we want to fulfil them.”
In an early, basic draft of a coalition policy platform, the two sides would ask the EU for flexibility on the 2020 budget deficit to “reinforce social cohesion” in the country, financial daily Il Sole 24 Ore said on Thursday.
The EU imposes budget rules on member states with the aim of ensuring financial stability in the bloc. It has had a testy relationship with Rome under the outgoing administration, with Salvini blaming the EU rules for impoverishing Italians.
The prospect of a new administration led by Conte has buoyed markets, which are betting that Italy will get a fiscally prudent government that will avoid confrontation with Europe.
Italian government bonds maintained their rally into Thursday, with the yield on 10-year debt trading around an all-time low it touched on Wednesday..
The League is highly eurosceptic and had promised swingeing tax cuts for 2020 that economists warned could put unsustainable pressure on Italy’s towering debt mountain.
However, a coalition pact is not yet a done deal. The tentative accord could still unravel with 5-Star and the PD yet to agree on other top government posts, besides the prime minister’s position, or reveal a common policy platform.
Unexpectedly, the founder of the 5-Star Beppe Grillo issued a statement late on Wednesday saying the ministers should be technocrats and not elected politicians — a suggestion that is unlikely to gain traction with the PD.
In an added complication, 5-Star has said it will put any deal with the PD to an online vote of its members. Many 5-Star supporters have taken to social media to denounce a pact with the centre-left and a ‘yes’ vote cannot be taken for granted.
Writing by Crispian Balmer; additional reporting by Valentina Consiglio, Gavin Jones in Rome; Editing by Jon Boyle