Italy budget tussle goes down to wire, upsets markets

By Giuseppe Fonte

ROME (Reuters) - Italy's new government struggled to contain a fierce internal battle over fiscal policy on Thursday, hours before it was due to unveil its 2019 budget deficit target, sparking a sell-off of state bonds and reviving fears the economy minister could quit.

The battle between the ruling parties' leaders and the fiscally conservative minister intensified, with some coalition voices publicly telling the minister he should resign if he couldn't back their spending plans.

Prime Minister Giuseppe Conte's office denied a report that a cabinet meeting to agree the deficit figure would be pushed back a day or two, but a government source said it had slipped by two hours and was seen starting at about 8 p.m. (1800 GMT) in Rome.

Investors had interpreted the unsourced report in Corriere della Sera newspaper that the meeting would be delayed as a sign Economy Minister Giovanni Tria may indeed resign, sending bond yields sharply higher

Tria's office denied again on Thursday that he would quit.

The ruling coalition made up of the anti-establishment 5-Star Movement and the right-wing League are pushing Tria, an academic not affiliated to either party, to ramp up the fiscal deficit to finance their promises of tax cuts and higher welfare spending.

"A battle is underway between us and Tria," a 5-Star source said. "Tria is holding to the 1.6 pct (of gross domestic product) deficit target and has threatened to resign. We have told him that he can go."

"The ruling parties are in agreement," the source added.

The chief whip for the League party said Tria should leave if he could not accede to the ruling parties' desired deficit target.

"If Tria agrees with us, then OK, but if not we'll find another minister," Riccardo Molinari told Reuters.

Before the cabinet meeting, Conte, Tria, the ruling party leaders and other key ministers will meet to hammer out differences, 5-Star leader and Deputy Prime Minister Luigi Di Maio said.

A government source said that meeting will start at 4 p.m. (1400 GMT).

Financial markets have been nervous since the government took office in June due to fears its spending plans will boost Italy's debt, which is already the highest in the euro zone after Greece's as a proportion of GDP - around 131 percent.

Italy's government bonds had rallied this week on the expectation Tria could water down the coalition's more radical proposals and keep a lid on public finances.

DEFICIT LIMIT

At its meeting, the cabinet is due to sign off on targets for economic growth, the deficit and public debt for 2018-2021, with most attention focused on the 2019 deficit goal.

Tria was now willing to accept a ratio of around 1.9 percent, government sources have said.

That would compare with a current target of 1.6 percent for this year, and would be sharply up from a 0.8 percent goal pencilled in for 2019 by the previous centre-left administration.

Tria's Treasury department forecast that a 2019 deficit above 1.9 percent would put at risk the containment of Italy's debt, a source familiar with the matter said on Thursday.

The targets form the framework for the 2019 budget, which must be approved by the cabinet by Oct. 20.

Tria said on Wednesday the budget would include the parties' flagship policies, including a basic income for the poor and a lower retirement age, though it remains unclear how wide-ranging such measures will initially be and how they will be financed.

The League and 5-Star, rivals ahead of an inconclusive election in March, say they will govern together for a full five-year term and phase in most of their policies gradually.

(Additional reporting by Massimiliano Di Giorgio and Giselda Vagnoni in Rome and Francesco Guarascio in Brussels, writing by Steve Scherer and Gavin Jones, Editing by Mark Bendeich and Toby Chopra)