ROME Italy's revised growth and budget targets are consistent with a balanced budget in the medium term and creating a "sizable" primary surplus to cut the country's massive 1.9-trillion-euro debt, according to an internal European Commission document.
The assessment, a technical document which will be submitted to senior EU officials, comes after Italy said on Wednesday its deficit would be 0.5 percent of gross domestic product next year, up from a previous forecast of 0.1 percent, which will be reached instead in 2014.
The government forecast an economic contraction this year of 1.2 percent, almost in line with the Commission's forecast of a 1.3 percent drop in output.
Prime Minister Mario Monti, when he took office five months ago, signed up to predecessor Silvio Berlusconi's goal of balancing Italy's budget by next year.
Challenges to that target have grown, however, as the economy has fallen into recession and domestic resistance has increased to Monti's program of reforms - one of the main risks in Europe's still-deepening debt crisis.
"The government's policy response has so far been determined and wide-ranging. It has to be implemented in full and as a matter of urgency," said the document, obtained by Reuters on Thursday.
The commission document, like Monti himself, emphasized that Italy will post a structural - adjusted for the business cycle - budget surplus of 0.6 percent next year.
The important thing is that Monti reform efforts be continued, the labor reform proposal be passed, and that "sound" management of the public finances be continued "beyond 2013," after next year's national election, the commission said.
It also urged Italy to make additional structural reforms aimed at boosting growth.
A 30-billion euro austerity plan that Monti rushed through at the end of last year, made up largely of tax increases, is partly to blame for this year's recession, which has in turn worsened the outlook for public finances.
Accepting slippage on the deficit goal may help Italy break the austerity-recession-austerity vicious circle common to other euro zone countries like Portugal and Greece that have had to be bailed out.
The yield on Italy's 10-year benchmark bond has come down to about 5.6 percent from highs above 7 percent reached at the end of last year shortly after Monti took over for a discredited Berlusconi.
After the new forecasts were published Wednesday, bond yields rose only slightly and in line with other euro zone peripheral countries.
However, Italy's yields are inching back up as investors grow increasingly wary of Spain's commitment to fiscal discipline and amid rumors on Thursday that France's sovereign bond rating could be downgraded.
The yield gap between Italian benchmark bonds and safer German Bunds rose on Thursday to 4 percentage points, compared with a recent low of 2.8 points in March.
The yield on Spain's 10-year benchmark hovered around 6 percent on Thursday.
Italy's budget deficit is one of the lowest in the euro zone as a proportion of output, whereas Spain's is one of the highest, and its new Prime Minister Mariano Rajoy has yet to earn the levels of investors' confidence that Monti, an economist and former European commissioner, enjoys.
Spain has seen its bond yields rise sharply since it tried last month to raise its deficit goal for this year to 5.8 percent of GDP from 4.4 percent, and then compromised with its EU partners on a 5.3 percent goal.
(Writing by Steve Scherer; editing by Patrick Graham)