* Bloc's financial stability on the up
* France unlikely to meet budget deficit ceiling
* Italy needs tax, judicial reforms (Adds details on Italy, France)
BRUSSELS, May 22 (Reuters) - Euro zone countries improved their fiscal stance, a sign of growing financial stability, the EU Commission said on Monday, but it called on France to take new action to comply with EU deficit limits and warned Italy faced "urgent" challenges.
Every spring the EU executive publishes an assessment of the fiscal positions of each of the 28 EU member states, along with its recommendations for economic reforms and for disciplinary measures against those with unbalanced budgets.
The 19-country euro zone has lowered its total budget deficit to 1.5 percent of the bloc's gross domestic product in 2016. The Commission forecasts the gap is to fall further this year and next, well below the 3 percent of GDP limit.
The EU as a whole had an aggregate deficit of 1.7 percent last year, which is also set to decrease.
In its report the commission recommended an end to disciplinary procedures against Portugal and Croatia due to improvements in their public finances. The commission's recommendations must be approved by EU finance ministers to come into force.
But around the bloc economic recovery and budget improvements were "uneven," Economics Commissioner Pierre Moscovici said in a statement.
France, along with Spain, Greece, Britain, will continue to face disciplinary procedures for its excessive budget deficit.
Disciplinary steps against France, the euro zone's second largest economy, have been in place since 2009. It has until the end of this year to bring the budget shortfall below the EU ceiling of 3 percent of GDP.
The Commission forecasts France's deficit will this year shrink to 3.0 percent this year but rebound again to 3.2 percent next year, unless the government appointed by French President Emmanuel Macron takes action.
"France needs to stand ready to take further measures to ensure compliance in 2017 and ... further measures will be needed as of 2018 to comply with the provisions of the Stability and Growth Pact," the Commission said.
France must cut its structural deficit -- the measure that excludes business cycle swings and one off spending and revenue -- by a minimum of 0.4 percent of GDP next year, but under existing policies that deficit is predicted to rise 0.5 percent of GDP.
But the Commission also signaled it would apply discretion in the application of its budget rules to allow France to take any measures to strengthen its economy that would help it comply.
"In that context, the Commission intends to make use of the applicable margin of appreciation in the light of the cyclical situation of France," the Commission said.
Italy, which after Greece has the bloc's largest public debt, faces "urgent challenges," the Commission said, though it sees additional budget measures adopted by Rome in April as sufficient to keep Italy's accounts in line with EU rules for this year.
Nonetheless the Italian government needs to make "substantial fiscal efforts" and carry out important reforms next year, targeting taxation, excessively long civil trials and the reduction of bad loans in troubled banks.
Italy has asked for more time to sell non-performing loans in an attempt to obtain better prices and reduce capital shortfalls in ailing banks.
Any austerity measures imposed by the EU on Italy could strengthen the country's eurosceptic parties, which are on the rise as the country gears up for elections due by May 2018. The bloc's pact for fiscal accountability is already unpopular in Italy.
The Commission pledged to use all possible leeway to review the agreed target of a structural correction of at least 0.6 percent of the Italian GDP next year.
Italy is forecast to have the slowest growth in the EU this year and next at around 1 percent of GDP. (zfraguarascio; Editing by Raissa Kasolowsky)