I agree with @Topsecretidentity
I have been invited, and stayed with, friends and family friends for 5-7 nights and never been charged. Then again we always had at least one conversation where I said its a long time, I dont mind staying in a hotel for all or part of it, and they insisted it was fine. In each case i turned up with expensive champagne and treats and paid for our own food. I would have been horrified if I had been asked for that sort of money and 5 dags notice and I agree with others that it sounds like perhaps your host is either not keen on your visit or perhaps thinks that £800 isnt much (is she loaded?).
However I doubt it is the latter as southern italy is cheap as chips, I spend lots of time there.
I think you should still go, but have an honest conversation and find somewhere else to stay. As @topscretidentity has pointed out, you can find something much cheaper and more importantly within your budget.
I would book somewhere near her, and get in touch and say something like "we are all reallly looking forward to seeing you, but I think there have been some crossed wires. When we offered to pay something towards our stay we werent expecting anything as much as £800 plus food, and I am really sorry but we just can't afford it. We have booked an airbnb nearby which is more within our budget and we are looking forward to spending some time with you"
If she is a good friend you can have a chat about it when you are out there and check that she didn't feel you were using her like a hotel. Alternatively you can stay with her for 1 night, but it might be easier just not to!
Even if you can't find an airbnb there are lots of affordable b&bs which are often lovely. Have you got a car or are you relying on her for transportation? Because I would definitely get your own car. That can be expensive at short notice but we haveused www.sicilybycar.it/rent/Index.aspx which was cheap and you can purchase the extra insurance from them in advance