Italy hikes growth outlook but budget deficit to rise from next year

By Giuseppe Fonte and Gavin Jones

ROME, Oct 2 (Reuters) - Italy on Friday raised its economic growth forecasts and said the 2026 budget deficit would fall inside the European Union's limit for the first time in seven years, only to rise again from 2027.

In new multi-year forecasts that will form the basis for the 2027 budget later this month, the government said gross domestic product in the euro zone's third-largest economy would rise by 1% in 2026, hiking a previous estimate of 0.6% made in April.

Next year's growth outlook is raised to 0.8% from 0.6%, Economy Minister Giancarlo Giorgetti said in a news conference.

MELONI FACING DIFFICULT PRE-ELECTION BUDGET

Prime Minister Giorgia Meloni is putting together the 2027 budget - her last before national elections due next year - against a difficult economic backdrop.

Surging energy prices are driving up inflation, government borrowing costs are climbing, and the public debt is expected to overtake Greece's this year as the highest in the 21-nation currency bloc.

"I'm monitoring the situation day by day. I think we need to take a cautious approach," Giorgetti said.

He confirmed a pledge to bring the budget deficit below the EU's 3% of GDP ceiling this year, a goal that Italy marginally missed last year with a 3.1% reading.

However, neither the minister nor his staff have clarified what this year's deficit target will be, or whether the 2.9% estimate made in April will be confirmed.

The fiscal gap will rise in 2027 to 3.4% of GDP from a previous 2.8% goal, Giorgetti said, as Italy uses leeway granted by EU to allow all the bloc's countries to hike defence spending and tackle the energy crisis triggered by turmoil in the Middle East.

Moreover, the country's massive public debt will start to fall only in 2028, one year behind schedule compared with the April framework.

Nonetheless, Italy's chronically sluggish economy held up better than expected over the first half of the year, supported by a steady flow of billions of euros of EU COVID-19 recovery funds, of which Italy is the bloc's biggest beneficiary.

DEFICIT AND DEBT TO RISE AS ITALY TAPS EU LEEWAY

The sharp hike in the 2027 deficit target reflects Rome's recourse to the EU's "national escape clause" (NEC) from its budget rules, to allow higher defence and energy-related spending.

Italy will ask the EU for deficit leeway through the NEC worth 0.6% of GDP both in 2027 and 2028, Giorgetti said. As a result, the 2028 deficit is now set at 3.3% of GDP.

In cash terms, the extra spending will amount to around €14 billion ($15.76 billion) each year.

Giorgetti said he was in talks with the European Commission to ensure the higher deficit does not prevent Italy from exiting an EU budget disciplinary procedure in mid-2027.

"The deficits in the next two years are above 3% of GDP, but they must be adjusted to exclude the extra spending for defence and energy; consequently, we are below 3%," he said.

MELONI SEEKING MORE BUDGET FLEXIBILITY

Meanwhile, in a constantly evolving situation, Meloni this week sent a letter to the EU calling for "additional flexibility" in budget rules ‌to help governments counter an energy-driven spike in inflation.

Italy's annual inflation rate jumped to 4.1% in September from 3.2% the month before.

Meloni is urging the EU to allow member states help their economies through extra revenues stemming from the so-called "fiscal drag", by which inflation and nominal pay growth raise the proportion of taxes paid on income.

Italy's public debt is seen peaking at 138.5% of GDP next year from 138.1% in 2026, before falling to 137.9% in 2028.

($1 = 0.8886 euros)

(Reporting by Giuseppe Fonte and Gavin Jones)