UPDATE 4-Brussels says Italy missing debt target, reviving dispute

The European Commission said on Wednesday that Italy's growing debt broke EU rules, giving it the option of opening a disciplinary procedure that could lead to a prolonged dispute with Rome. Brussels insisted the process could be stopped if Rome changed course, but the initial reaction from Italian government figures suggested a little appetite for a budget rethink.

Italy averted the same procedure at the last minute in December by committing to cut its deficit this year. However, after new data showed it was not meeting its commitments, the Commission returned to the attack, saying not enough had been done to cut debt levels. "To be clear, today we are not opening a procedure," the EU commissioner for the euro, Valdis Dombrovskis, told a news conference, noting that other steps were needed to formally begin the process.

European Union states would in the next two weeks have to back the Commission's assessment that a procedure is warranted. After that, Brussels could recommend starting the procedure, which could happen before a meeting of EU finance ministers in early July. EU economics commissioner Pierre Moscovici said his "door is open" to change the analysis if Italy made new commitments.

The procedure could potentially lead to financial sanctions and stricter oversight of Italy's public finances. Although fines remain unlikely, the fight with Brussels exposes Rome to increased market pressure. Italian banks were down over 2.2% by 1410 GMT, and the yield on Italy's 10-year government bonds was up two basis points at 2.545%.

RISK TO EUROZONE

Deputy Prime Minister Matteo Salvini, whose League party triumphed in last month's EU parliamentary election, on Wednesday ruled out any austerity measures to lower Italy's debt mountain, saying this would inflict further harm on the economy.

"The only way to reduce the debt created in the past is to cut taxes," he said in a statement. Salvini's fellow deputy prime minister, Luigi Di Maio, who heads the anti-establishment 5-Star Movement, said Rome was ready to talk to Brussels but complained that the Commission was picking on Italy while letting other offenders off the hook.

France, Belgium and Cyprus have all been cautioned about their finances by Brussels, but are not under as much pressure because the Commission deemed their reform efforts sufficient. "... It's very annoying that every day a new way is found to speak badly about Italy and this government," Di Maio said.

Italy's public debt, the second highest in the EU in proportion to output after Greece's, rose from 131.4% of gross domestic product (GDP) in 2017 to 132.2% in 2018. The Commission estimates that it will go up to 133.7% this year and 135.2% in 2020, in breach of EU rules that say it should go down.

The International Monetary Fund identified Italy's debt as a major risk to the eurozone economy, along with global trade strains and a hard Brexit, an EU document showed, anticipating a report the IMF will present next week. The EU Commission is in charge of monitoring EU countries' budgets and is obliged to publish reports on states that appear to deviate from agreed fiscal targets.

The Commission said the debt was growing because the interest rates Italy has to pay to service it was expanding faster than the economy. Brussels estimates that Italy last year paid 65 billion euros ($73 billion) in interest on its debt, "as much as for the entire education system", Dombrovskis said.

The Commission's forecasts are more pessimistic than Italy's estimates. Rome expects the debt to rise this year to 132.6% of output, and decline to 131.3% in 2020. The difference is mostly due to the fact that the Commission is not including in its forecasts a hike in sales tax next year, which Italian government officials have repeatedly said they will try to avoid - even though revenues from the tax hike are already included in its economic forecasts.

The Commission report said Italy had made only limited progress in addressing EU economic recommendations and had backtracked on necessary structural reforms, such as a pension reform that Italy's eurosceptic government softened. The Commission said this "may negatively affect Italy's growth potential".

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