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UPDATE 1-Italy's debt to climb as economy stalls, shedding jobs -EU

Francesco Guarascio

* Brussels downgrades could reignite budget dispute

* Says Italy economy to grow 0.1 pct this year, lagging bloc

* EU says debt, deficit to rise far above fiscal ceilings (adds Moscovici, details, Italy estimates)

BRUSSELS, May 7 (Reuters) - Italy's huge debt pile is expected to rise higher this year as the country's economy limps along, the European Commission said on Tuesday in quarterly forecasts that could reignite a dispute with Rome over its budget.

Brussels cut its 2019 growth outlook for Italy to 0.1 percent from an already gloomy 0.2 percent. The economy expanded 0.9 percent last year.

The commission also said it expected growth in the wider euro zone economy to slow more than previously estimated, to 1.2 percent.

But its forecast for Italy is the lowest in the bloc, and the Commission said it expected that to weigh on the country's public finances, with debt and deficit seen climbing far beyond what is allowed under EU fiscal rules.

The Commission's forecasts were drawn up before data showed Italy emerged from recession in the first quarter with stronger-than-expected growth of 0.2 percent, and the government says its policies to increase welfare benefits will support domestic demand.

Although no EU decision over possible disciplinary moves is expected before European elections on May 23-26, the more downbeat estimates could increase market pressure on a coalition government in Rome already plagued by infighting.

The commission - which came close to penalising Italy over an excessive deficit target before the two side reached an agreement in December - will assess states' compliance with EU rules at the beginning of June, economics commissioner Pierre Moscovici said.

EU SEES HIGHER DEFICIT, FALLING INVESTMENT

Without policy changes, Italy's deficit would be 2.5 percent of gross domestic product (GDP) this year and would climb to 3.5 percent in 2020, beyond the EU's 3.0 percent ceiling, the bloc's executive estimated.

The government has forecast a deficit of 2.5 percent this year and 2.1 percent in 2020.

The commission expects Italy's debt to grow to 133.7 percent of GDP this year and peak at 135.2 percent in 2020.

Euro zone countries with a debt rate above 60 percent are required to gradually reduce it. But Italy's has been growing since last year, when it cost 3.7 percent of economic output to service.

With Italian bond yields having dropped slightly after December's budget deal with Brussels, interest expenditure is forecast to drop to 3.6 percent of GDP this year, before rising again in 2020.

The structural deficit, which excludes one-off items and the effects of the business cycle, is also expected to worsen. This indicator is crucial in the EU assessment over countries' compliance with fiscal rules. The primary surplus, which excludes interest payments, is expected to ease.

Italy is the only euro zone country in which the commission expects employment to fall this year, by 0.1 percent. The government has also forecast that employment will decline this year. Both Brussels and Rome expect it to rise in 2020.

Brussels also singled out Italy as the only state where investments will fall, by an estimated 0.3 percent.

Italy's fiscal outlook could worsen if yields rose again, but would improve if spending was reduced and a planned rise of sales tax was applied next year, the Commission said. (Reporting by Francesco Guarascio; additional reporting by Gavin Jones in Rome; editing by Robin Emmott and John Stonestreet)