The surprise move came the day after outspoken Economy Minister Arnaud Montebourg had condemned what he called fiscal "austerity" and attacked euro zone powerhouse Germany`s "obsession" with budgetary rigour.
In a terse statement, Hollande`s office said Prime Minister Manuel Valls had handed in his government`s resignation, opening the way for a reshuffle just four months after it took office.
"The head of state asked him to form a team that supports the objectives he has set out for the country," the statement said, suggesting Valls would continue trying to revive the euro zone`s second largest economy with tax cuts for businesses while slowly reining in its public deficit by trimming spending.
France has lagged other euro zone economies in emerging from a recent slowdown, fuelling frustration over Hollande`s leadership, both within his Socialist party and further afield.
The new cabinet will be announced on Tuesday and there was no immediate word on who would stay and who would go.
If Hollande decided to sack Montebourg, who is viewed as a potential presidential rival, he would risk seeing the ousted minister take with him a band of rebel lawmakers and deprive him of the parliamentary majority he needs to push through reforms.
Opposition conservatives, who for weeks have been embroiled in their own leadership rows, called for an outright dissolution of parliament, as did the far-right National Front.
"With half of the presidential mandate already gone, it doesn`t bode well for the ability of the president, or whatever government he chooses, to take key decisions," said former Prime Minister Francois Fillon, one of handful of hopefuls for the conservative ticket in the 2017 presidential election.
"ALTERNATIVE MOTOR"
A new survey released at the weekend showed Hollande`s poll ratings stuck at 17 percent, the lowest for any leader of France since its Fifth Republic was formed in 1958. Valls, a once-popular interior minister, saw his own popularity eroded by his failure to tackle unemployment, which is stuck above 10 percent.
Despite being promoted within the cabinet to economy minister, Montebourg has emerged as the most visible leader of the left since Hollande in January adopted a more pro-business line to try and boost the economy with corporate tax breaks.
Hollande has also sought to repair ties with German Chancellor Angela Merkel`s conservatives that have been strained by France`s repeated failures to meet budgetary targets agreed with the Brussels-based European Commission.
Speaking at a meeting of Socialists in eastern France on Sunday, Montebourg said deficit-reduction measures carried out since the 2008 financial crisis had crippled euro zone economies and urged governments to change course swiftly or lose their voters to populist and extremist parties.
"The time has come for us to take on an alternative leadership, to set up an alternative motor," he told the gathering, where Education Minister Benoit Hamon also took Hollande`s policies to task.
The irony of the timing of Montebourg`s comments is that EU policymakers have in recent weeks acknowledged the bloc`s rules on budget consolidation should be followed with flexibility, while France this month conceded that stagnant growth meant it would miss its 2014 budget target.
Analysts said the showdown suggested the 51-year-old Montebourg -- who this year forced General Electric to sweeten its offer for French industrial icon Alstrom`s turbine business -- was looking to disassociate himself from Hollande and rally the country`s splintered left behind a rival presidential bid.
"Montebourg`s exit resonates like real ambition for 2017, that`s clear. It`s a real political coup," said Martial Foucault, director of the Cevipof think tank.
Foucault forecast that the government to be named by Valls on Tuesday would be more centrist in tone but noted: "You need ministers who are capable of speaking with unions, employers and Germany and, I admit, there are not a lot of alternatives."
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