February 7, 2019 / 12:10 PM / 8 days ago

UPDATE 1-EU cuts Italian growth outlook, says government caused recession

(Adds Italian minister, market reactions)

By Jan Strupczewski

BRUSSELS, Feb 7 (Reuters) - The European Commission slashed its forecasts for Italy’s economic growth in 2019 and 2020 on Thursday, saying uncertainty over government policies and higher borrowing costs have pushed the country into a recession.

Italian gross domestic product was likely to grow by 0.2 percent in 2019, the Commission said, down from 1.0 percent in 2018. It forecast 1.2 percent growth last November.

In 2020, the Italian economy was likely to expand by 0.8 percent, “helped by a positive carry-over effect and two more working days”, the Commission said. It had forecast 1.3 percent growth in November.

The forecasts depressed the FTSE Italia all-share index and Italian borrowing costs rose as 10-year bond yields increased 10 basis points to a one-month high of 2.942 percent.

The Italy-Germany 10-year yield spread rose 14 bps to its widest in two months.

Italy’s GDP contracted 0.1 percent in the third quarter and 0.2 percent in the last three months of 2018, putting the economy into a technical recession for the first time in five years.

“The recent slackening of economic activity is more attributable to ... uncertainty related to the government’s policy stance and rising financing costs took its toll,” the Commission said.

Italy’s borrowing costs surged in the second half of 2018 as investors grew worried that the populist government in Rome wanted to borrow more to finance generous welfare and pension policies, even though Italy already has the second-highest public debt in Europe at 132 percent of GDP.

ITALY NEEDS RESPONSIBLE POLICIES

“What Italy needs is deep structural reforms and decisive action to bring down high levels of public debt, in other words, responsible policies that support stability, confidence and investment,” Commission Vice President Valdis Dombrovskis said.

The Commission forecast Italian quarterly growth would be zero in the first three months of 2019 and just 0.1 percent in the second quarter against the previous three months.

Italian Economy Minister Giovanni Tria played down the economic difficulties, saying growth had stalled but it was wrong to say the country was in a recession.

“For now, we can talk about a setback rather than a real recession,” Tria told parliament. But he added that indicators showed that Italy was facing “growing difficulty in maintaining previous output levels”.

The weak economic performance raises questions over whether Italy can deliver the planned budget deficit of 2.04 percent of GDP this year — a hard-won compromise agreed with the Commission last year.

The Commission had wanted to put Italy into an EU disciplinary procedure, which could mean fines, over Rome’s plan to increase the budget deficit to 2.4 percent of GDP in 2019 through tax cuts and spending on welfare and earlier pensions.

In the end, Italy avoided the disciplinary steps by cutting the target to 2.04 percent, but that assumed economic growth would be 1.0 percent.

Tria said that the government had no plans to adopt corrective measures to rein in the budget deficit. (Additional reporting by Giuseppe Fonte; Reporting By Jan Strupczewski; editing by Philip Blenkinsop, Larry King)

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