By BLOOMBERG

ROME • The European Union (EU) has put numbers on its frustration with Italy.

After weeks of accusing Rome of too-optimistic assumptions about the effect of its spending plans, it said yesterday that economic growth next year will be weaker than the government targets, and the nation’s budget deficit will move dangerously close to the EU limit of 3%.

The report, part of an overview of the European economy, marks another shot in the dispute between authorities in Brussels and Italy’s government over the latter’s expansionary budget. The government said its measures are needed to support an economy that’s under performed the euro-area for years and boost the incomes of its people, but the EU and investors are worried what that will do to the country’s mountain of debt.

While the EU’s forecast language is gloomy, the reality may turn out to be worse.

“Even the EU forecasts themselves look too optimistic,” said Lorenzo Codogno, visiting professor at London School of Economics and a former chief economist at the Italian Finance Ministry. “The impact of higher borrowing costs on the banks’ loan rates is set to limit economic growth even further.”

In the report, the European Commission forecasts:

• Economic growth of 1.2% next year, below the populist government’s target of 1.5%.
• Weaker expansion has implications for the budget deficit, which is seen widening to 2.9% next year and 3.1% the following year.
• The government’s targeted 2.4% deficit for 2019 was flatly rejected by the commission.

It said the growth outlook is subject to “high uncertainty amid intensified downside risks”, including a further jump in government borrowing costs. Italy’s fiscal targets have already sent Italian bond yields to a four-year highs.

Italian bonds extended losses after the report with the 10-year yield rising seven basis points (bps) to 3.41% and pushing the spread with equivalent German bunds to 296bps.

Given the “fiscal deterioration” and risks to growth, the EU also said Italy’s large debt to-GDP ratio won’t decline through 2020. The EU wants Rome’s budget plans revised, but the government is refusing to yield.

The commission warned about the impact of higher debt-financing costs on lenders, singling out Italy as one of the “high-debt euro-area countries” where “disruptive sovereign-bank loops could also re-emerge in case of doubts about the quality and sustainability of public finances”.

Finance Minister Giovanni Tria (picture) signalled this week that the government is not ready to budge on its controversial budget even as his euro-area counterparts called on Italy to prepare revised spending plans.

Still, he told reporters after a Monday meeting in Brussels that the government will pursue a dialogue with the Commission. In setting the Nov 13 deadline for a resubmitted budget, the commission said the original plan constituted a clear deviation from EU rules.

Tria will meet tomorrow in Rome with Portugal’s Mario Centeno, the head of the Eurogroup of finance ministers.