MNI: Italy-EU Dispute EU Goes Well Beyond EDP - BOI Sources

--Rome Govt. Rhetoric Risks Poisoning Relations With Brussels

     ROME (MNI) - Italy's dispute with Brussels goes well beyond the possibility

of an Excessive Deficit Procedure (EDP) and risks turning into a protracted

political clash which risks raising further market volatility, Bank of Italy

sources told MNI.

     "It looks like a deal with the European Commission might be struck and it

(an EDP) will not be the case. Financial markets are very relaxed at present,

confident in a compromise, but we need to look at the wider, longer-term

picture," cautioned one of those at the central bank speaking to MNI.

     "There are other factors of concern, primarily the attitude of Rome's

government towards the European institutions which is not cooperative, and the

use of harsh language that exploits the negative power of words that can be

detrimental and must be properly weighed."

     On Monday, the Italian government decided to cut back deficit spending this

year to 2.04% of GDP, down from April's 2.4% projection, in a last-minute effort

to persuade Brussels to grant it more timing over its fiscal adjustment path by

averting an EDP. The Commission is expected to make a final decision this week,

though the process has been delayed by the stalemate in agreeing new

appointments to the top EU positions.

     --BRUSSELS FIRING BLANKS

     If Rome succeeds in avoiding an EDP, it would mark the second time the

ruling populist coalition has dodged the EU's fiscal disciplinary machinery

since the 5 Stars Movement and League Party rose to power just over a year ago.

     "Market volatility, paradoxically, is not triggered by what happens at EU

level, or at least to a minor degree, but what really causes instability are the

aggressive, combative announcements and statements made by certain members of

government which have the negative effect of triggering sudden hikes in the

spread between Italian and German bonds", complained another BOI source.

     The 10-year Bund-BTP spread narrowed to 220 basis points at the start of

this week as confidence rose that a deal between Rome and Brussels was at hand,

around its narrowest point since last year's elections.

     "Words are the real risk. Italy could face a prolonged conflict with the EU

even once the EDP is over or archived," the source said. "Rome is already paying

a high political cost for its words. Many EU countries have faced an EDP,

including France, for which the EDP revealed itself at the end of the day to be

more politically negative rather than economically devastating." the source

continued.

     "Let's hope Italy does not develop a longstanding, negative attitude

towards the new European Commission

     as this would have a serious impact on market confidence and debt-interest

costs at a delicate moment when spread levels are finally normalizing."

     --AUTUMN SHOWDOWN

     According to Carlo Cottarelli, a leading economist and former IMF official

who was briefly Italy's prime minister-designate in 2018, the time for a real

showdown between Brussels and Italy will be in September when the government is

expected to find E23 billion to avoid an automatic VAT rise previously agreed

with Brussels.

     "If Rome fails to raise alternative resources to avert the tax hike as

pledged to voters, the country's deficit could rise to 3.5% of GDP, thus

breaching EU budget rules," warned Cottarelli, today the director of the Public

Accounts Observatory at Milan's Catholic University.

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

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