By Gavin Jones and Valentina Za
ROME (Reuters) -Italy is under growing market scrutiny as Prime Minister Giorgia Meloni prepares a difficult 2024 budget, with investors dismayed by government moves affecting sectors from banks to airlines.
The Treasury will issue new economic targets on Wednesday providing the framework for a budget in which Meloni will attempt to keep her tax-cutting promises while also lowering the fiscal deficit.
The task is made all the harder by a weakening growth outlook and costly financial incentives for green home improvements which were introduced long before she took office but continue to weigh on public accounts.
"This budget is Meloni's first real economic test since she came to power last October," said Tim Jones, euro zone analyst for market consultancy firm Medley Advisors.
"With the European Central Bank backing off as a buyer of Italian bonds she's now going to have to make the kind of choices that have slow-punctured every other Italian coalition for the last 30 years."
Meloni has much less room for manoeuvre than when she hiked deficit targets in her first budget a year ago.
Now there is a growing emphasis on fiscal consolidation at the European level, with governments negotiating over new fiscal rules to be introduced next year after they were suspended in 2020 due to the COVID-19 pandemic.
This comes amid signs of souring market sentiment towards Italy, something Meloni can ill afford as long as she needs buyers for a public debt equal to about 142% of national output, proportionally the second largest in the euro zone after Greece.
'HIGHER DEFICITS, LOWER GROWTH'
The gap between the yields on Italian benchmark 10-year BTP bonds and safer German Bunds has risen to around 1.86 percentage points (186 basis points), the widest since late May.
"The supportive factors that allowed the spread to reach our 160 basis point bull-case scenario have vanished," Morgan Stanley said this month in a note to clients. "We expect higher fiscal deficits and weaker growth."
It forecast the spread would rise to 200-210 basis points by the end of the year.
Italy now expects this year's deficit to overshoot at around 5.5% of GDP compared with a 4.5% official target, sources have told Reuters.G
Rome also plans to raise its 2024 budget deficit target to between 4.1% and 4.3% of GDP, up from the 3.7% goal set in April, sources familiar with the matter told Reuters on Monday.
After a cautious start, Meloni's rightist government began raising investors' eyebrows when it repeatedly attacked the European Central Bank over its interest rate hikes, and then refused to sign off on an EU reform of its bailout fund.