Italy to cut spending, jobs despite union threats

* Monti seeks at least 5 bln euros of cuts

* Cuts needed to avoid hike in sales tax, strengthen public finances

* Unions have threatened strikes, centre-left uneasy

By Giuseppe Fonte

ROME, July 5 (Reuters) - Italy's cabinet met on Thursday to approve emergency legislation to reduce state spending and cut public sector jobs, setting up a showdown with unions who have threatened a nationwide general strike.

The government is making the cuts to avoid the need for a 2 percentage point hike in sales tax which is otherwise due to come into force in October and fund emergency help for the earthquake damaged Emilia-Romagna region.

The cabinet began meeting at around 1600 GMT and officials said it may adjourn until Friday before approving the contested package of measures.

If Monti succeeds with the cuts, expected to be worth around 5 billion euros for this year, they will also bolster public finances amid concerns that Italy will struggle to lower its budget deficit as targeted this year to 1.7 percent of output.

The deficit in the first quarter stood at 8 percent of GDP, up from 7 percent in the same period of last year and the highest since the start of 2009.

The package will reduce health expenditure, cut funding to local authorities and gradually trim the number of public sector workers by 10 percent and reduce state managers by 20 percent, according to a draft of the plan obtained by Reuters.

The plans do not envisage significant lay-offs and will be achieved mainly through hiring freezes and schemes to encourage early retirement. The level of job reductions also refers to planned notional staffing levels rather than the number of functionaries actually employed, which may be lower.

Some workers will be sent home for two years on 80 percent of their salary before being laid off or sent into retirement.

Labour unions, who put up tough opposition to Monti's labour market reform which parliament approved last month, are fiercely resisting public sector job cuts and the centre-left Democratic Party (PD) has also expressed misgivings about the package.

"Be careful of creating social conflict," Susanna Camusso, leader of Italy's largest labour union, the Cgil, said this week.

SUMMIT BOOST

However, buoyed by an EU summit last week where he won support for a proposal to use the region's bailout funds to potentially stem Italy's borrowing costs, Monti seems determined to press ahead.

By presenting the package as a decree, Monti will leave the parties less scope to amend and water down the measures. The decree is immediately effective, but must be passed by parliament within 60 days or else it expires.

Preventing an unpopular tax increase, even if it means angering public sector employees, may help revive Monti's popularity, which is hovering near its lowest level since he took office in November.

The cuts also may reassure financial markets that Italy has a handle on its budget deficit even though the economy is mired in a severe recession which shows no sign of easing.

Borrowing costs fell after the EU summit, but rose again on Thursday after the European Central Bank seemed to rule out additional measures to bring down interest rates.

Other measures included in the decree focus on the health sector.

The financing of a national health fund will be reduced, pharmaceutical companies will be required to give the state a larger discount for medicines, and regions will have to adopt measures to reduce the number of hospital beds.