Mr Berlusconi said he sees Italy holding early elections at the start of February and that he will not be a candidate for office.
“I will resign as soon as the [budget] law is passed, and, since I believe there is no other majority possible, I see elections being held at the beginning of February, and I will not be a candidate in them,”
Mr Berlusconi has dominated Italian politics for the last 17 years.
“The government no longer has the majority that we thought we had,” he told a television station minutes after his resignation announcement.
“Therefore, to be realistic, we have to acknowledge the situation and concern ourselves with Italy’s situation and with what is happening with the markets.”
Stocks in the US rose after his statement.
His announcement follows a vote in parliament on the budget in which he appeared to lose his majority.
Speaking on TV, the prime minister said he would have preferred to call early elections but the final decision rested with President Giorgio Napolitano.
“Once this finance law is approved, along with the amendments on everything which Europe has asked of us and which the Eurogroup has asked for, I will resign, so that the head of state can open consultations,” he said.
Earlier, President Napolitano announced the decision in a statement.
“Once this engagement is fulfilled, the prime minister will hand in his mandate to the head of state who will proceed with appropriate consultations, paying close attention to the positions and proposals of all political forces,” he said.
Bolstered by unrivalled communication skills and a dominance of Italian media, Berlusconi had for years seemed immune to a series of controversies that would have destroyed a politician in most other parts of the world.
They included the lurid “Rubygate” scandal in which he was charged with having sex with an under-age prostitute, and included a wave of salacious revelations from police wiretaps about alleged orgies at his luxurious Milan villa.
He also faces two ongoing fraud court cases, the latest in more than 30 prosecutions by magistrates he accuses of being communists bent on perverting democracy.
Berlusconi, 75, one of Italy’s richest men, had been in political decline for most of this year, his former mastery undermined by glaring misjudgments in local elections and three referendums as well as the loss of a key alliance.
A vote on the reform measures is planned for next week, giving Berlusconi a few more days before his turbulent 17 years in public life — and a political era in Italy — draw to a close.
Over the years, Italy’s political establishment watched as the media mogul survived sex scandals and corruption charges while branding his opponents communists, traitors and terrorists.
Italy’s borrowing rates spiked Tuesday to their highest level since the euro was established in 1999. The yield on Italy’s 10-year bonds was up 0.24 percentage point at 6.77 percent.
A rate of over 7 percent is considered unsustainable and proved to be the trigger point that forced Greece, Portugal and Ireland into accepting bailouts.
Berlusconi’s resignation may not be enough. Political analyst Sergio Romano, in a front-page column in Corriere della Sera on Tuesday, warned that unless a clear program emerges in a post-Berlusconi era “the foreign observers will reach the conclusion that the end of the Berlusconi goverenment does not necessarily mean the advent of a more credible, trustworthy government.” [via Reuters, The Telegraph, Yahoo! and BBC]