NEW YORK (Reuters) - A New York City museum said Tuesday it would go ahead with a controversial art exhibit this week, despite threats by an enraged Mayor Rudolph Giuliani to evict the museum from its city-owned site and yank millions of dollars in public funds.

Both the Brooklyn Museum of Art and the city vowed to take their battle to federal court, where the museum filed a lawsuit late Tuesday seeking to stop New York City from cutting off its funds.

The controversy was sparked by ``Sensation,'' a collection of works by young British artists that includes an elephant dung-stained portrait of the Virgin Mary.

The mayor has declared he finds the portrait offensive, and city attorneys said they will counter in court to keep the exhibit from opening.

Museum Chairman Robert Rubin said in a statement that its legal battle was launched ``in the interests of all public institutions -- museums, universities and libraries -- that are dedicated to the free exchange of ideas and information, and in the interests of the people they serve.''

The museum hired renowned First Amendment lawyer Floyd Abrams to handle the lawsuit.

``Under the First Amendment, this museum may not be punished for offering to the public an entirely lawful exhibition,'' Abrams said. ``That's what this is all about.

``This is an effort at retribution, punishment, sanctions imposed against the museum, and the First Amendment does not allow it,'' he said.

The decision to proceed with the ``Sensation'' show came after an emergency meeting of museum directors of more than an hour.

The nearly-unanimous vote -- the mayor's representative on the board cast the sole dissenting vote -- came after talks seeking a compromise failed.

Giuliani is threatening to withdraw $7 million in city subsidies from the museum, the city's second largest, and to evict it from its city-owned premises, if the show opens as planned Saturday.

The city provides nearly one-third of the museum's $23 million budget.

``We did try to settle this in an appropriate way,'' said the lawyer for the city, Michael Hess, after the board meeting.

``On the other hand, this exhibit is an improper exhibit. There's nothing in the constitution that says taxpayers should pay for an exhibit like this, with some of the really disgusting-type paintings that are being shown,'' he said.

The mayor has been publicly fighting the show, owned by Charles Saatchi, for nearly a week. The show also caused an uproar when it appeared at the Royal Academy in London in 1997 and elsewhere in Europe.

The mayor says the museum violated its lease with the city by requiring that children would need parental permission to see the show. The lease requires the museum to remain open to the public, including children, according to the mayor.

Taking aim at the mayor's argument, the museum's board of directors also voted Tuesday to allow children to see the exhibit unaccompanied, although it said it would post warning signs about the exhibit's contents.

The exhibit, with its use of pickled cow parts, cut outs from pornographic magazines and human blood, is a showcase for British artists Damien Hirst, Marc Quinn, Chris Ofili and others.