Markets brace for Italy's new budget proposal

An employee counts U.S. dollar banknotes at a currency exchange office in Jakarta

In a first for the European Union, the Commission rejected the budget last month, saying that it represented an "unprecedented deviation" from the bloc's spending rules.

The unlikely alliance of deputy premiers Luigi Di Maio and Matteo Salvini has stuck to the government's 2.4 percent budget deficit and 1.5 percent growth forecast targets for next year.

"The budget will not change, neither in its balance sheet nor in its growth forecast". In a nutshell, the Italian budget deficit is projected to be larger than their GDP growth which means that the debt-to-GDP ratio would increase. On top of the simmering tensions between the European Union and the Italian government, investors are also expressing concerns above the negotiations between the United Kingdom and EU over Brexit.

The far-right League and Five Star Movement (M5S) plan to run a public deficit of 2.4 percent of GDP in 2019 - three times the target of the government's centre-left predecessor - and 2.1 percent in 2020.

Italy will also promise "safeguard mechanisms" to ensure no overshooting of the 2.4% deficit target, the source said.

A report showing Italy is in breach of the EU's debt rules would be another step down the path toward potential financial penalties.

In its October World Economic Forecast, the International Monetary Fund predicted Italy would grow by 1 percent next year, 0.9 percent in 2020 and 0.8 percent in 2021 - far below government estimates.

Last week's meeting between Eurogroup President Mario Centeno and Giovanni Tria, the Italian Minister of the Economy, did not signal a breakthrough in the standoff.

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It would be "suicide" to attempt to reduce the deficit to the previous goal of 0.8 percent of GDP, he has said, insisting "we must get out of the trap of weak growth".

Speaking Tuesday to the European Parliament, German Chancellor Angela Merkel said the EU wanted to reach out to Italy, a founding member.

In a procedure for excessive deficit, European Union governments get several opportunities to weigh in and Italy could be given as much as six months more to comply once the process starts.

Last week the commission produced its own economic forecast, which contradicted Italy's predictions contained in its budget.

"The strong market reactions to political events in the past have sparked new concerns about the links between banks and sovereign debt in some parts of Europe - this is the basis of the request for fiscal discipline and compliance with the rules", he said.

Italy's rightwing populist government argues its planned budget will stoke the country's stagnant economy through a mix of generous welfare spending, tax cuts, and investments.

Uneasy investors, who demand a higher return to put their money into Italian assets, have already cost the taxpayer an additional 1.5 billion euros in interest over the past six months, according to the Bank of Italy.

A wider fear is that stress in Italy could spread to other European countries which are only just recovering from the eurozone debt crisis.

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