UPDATE 2-Italy cuts growth outlook, frets over instability
* Italy cuts 2013 GDP forecast to -1.7 pct
* Cuts 2014 GDP to +1.0 pct
* Pledges to correct 2013 deficit overshoot
* Debt forecast to hit new record in 2013, stable in 2014
By Giuseppe Fonte and Gavin Jones
ROME, Sept 20 (Reuters) - Italy cut its forecasts for the economy on Friday and pledged to correct a budget deficit that is set to overshoot EU limits as coalition in-fighting threatens the government's ability to make reforms needed to spur growth.
Prime Minister Enrico Letta told reporters the tensions which are undermining the stability of his broad left-right administration would have to end for it to counter a prolonged recession and consolidate Italy's strained public finances.
The new forecasts approved by the cabinet see the economy shrinking 1.7 percent this year compared with a 1.3 percent contraction projected in April.
In 2014 growth is now seen at 1.0 percent, down from 1.3 percent previously but still more optimistic than the expectations of most analysts.
The forecasts are "reasonable and achievable so long as there is political stability," Letta said at a news conference.
The prime minister said on Thursday he would not allow his government to be used as a "punching ball" by the bickering ruling coalition, as a new row erupted after centre-right leader Silvio Berlusconi attacked judges who sentenced him last month for tax fraud..
A Reuters survey of analysts in July pointed to 2014 growth of just 0.5 percent for Italy, while the International Monetary Fund in August forecast a 0.7 percent expansion.
Eight consecutive quarters of contraction have left the euro zone's third-largest economy in its longest post-war recession and recent data has cast doubt on hopes of a recovery soon.
After years of stagnation and contraction the economy is smaller now, in inflation-adjusted terms, than it was in 2001.
Economy Minister Fabrizio Saccomanni said he expected growth would be bolstered by the government's drive to pay debt arrears owed to private suppliers and shrugged off recent weak data on industrial output and orders.
He forecast that gross domestic product would be flat in the third quarter and that growth would return in the last three months of the year before consolidating in 2014.
The budget deficit is likely to be 3.1 percent of GDP this year on current trends, the government said, but Saccomanni told reporters it was "important this is corrected quickly" to meet the European Union's 3 percent ceiling.
The European Commission was more specific, calling on Friday for new measures by early November to avoid an overshoot.
Letta said the cabinet had not discussed the subject of the latest row to hit the ruling coalition: whether a hike in sales tax due to take effect in October should go ahead or be suspended as demanded by Berlusconi's centre-right.
One of Berlusconi's top economic spokesmen, Renato Brunetta, on Friday attacked Saccomanni and said the government would fall if the tax hike went ahead, despite the hole that scrapping it would tear in public finances.
The government sharply raised its deficit target for 2014 to 2.5 percent of GDP from 1.8 percent. It also hiked its forecasts for Italy's public debt, the second highest in the euro zone after Greece's and which has risen sharply in recent years.
The debt is now seen at a fresh record of 132.9 percent of GDP this year, up from a previously forecast 130.4 percent, and at 132.8 percent in 2014, up from 129 percent.
It is forecast to decline to 120.1 percent in 2017, according to government figures, but this is dependent on asset sales worth 0.5 percent of GDP per year from 2014.
In recent years successive governments have proved unable or unwilling to follow up on plans to sell real estate or stakes in state companies in order to reduce the debt.
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