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Italy vs the EU? Markets spooked as Europe prepares for another budget showdown

Key Points
  • Italy's Deputy Prime Minister Matteo Salvini said Tuesday that Rome could be hit with a fine of 3 billion euros ($3.4 billion) for accumulating debt and deficits that break EU rules.
  • European Commission Vice President Valdis Dombrovskis told CNBC's Silvia Amaro on Tuesday that he could not confirm whether Italy would be slapped with a hefty fine.
  • The Commission is set to review Italy's finances again on June 5.
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Italy has used 'most of' the flexibility with EU fiscal rules: Dombrovskis

An intensifying dispute between Italy and the European Union hit financial markets on Tuesday, with investors bracing for another budget showdown between Rome and Brussels.

European stocks and the euro were both trading lower during afternoon deals, following reports the euro zone's third-largest economy could soon face disciplinary steps from the EU's guardian of healthy public finances.

Italy's Deputy Prime Minister Matteo Salvini said Tuesday that Rome could be hit with a fine of 3 billion euros ($3.4 billion) for accumulating debt and deficits that break EU rules.

Speaking shortly after his anti-immigration Lega party triumphed in European elections, Salvini said he would use of all his energy to fight what he claimed were outdated and unfair European fiscal rules.

European Commission Vice President Valdis Dombrovskis told CNBC's Silvia Amaro on Tuesday that he could not confirm whether Italy would be slapped with a hefty fine.

But, he said the EU's executive arm — the European Commission — did have "some concerns" about Italy's fiscal trajectory.

In the event of a fine, the sanction would require the approval of EU finance ministers.

'Important' to ensure financial stability

"We see that the budget deficit is higher than previously expected and public debt also is not going down — which certainly should be the case for a country that has the second-highest debt-to-GDP (gross domestic product) ratio in the EU, " Dombrovskis said.

He explained there was now plenty of evidence to show Italy's current spending plan was not delivering its intended results.

Dombrovskis said the country's approach to public spending had led to "some degree" of financial instability, triggered higher interest rates both for sovereign lending and the broader economy, undermined investor confidence and caused the country to endure the slowest rate of expansion of any economy in the EU.

"So, from that point of view, we think it is important to reconsider this fiscal trajectory, to ensure financial stability and to ensure Italy can return to more rapid economic growth," he added.

Matteo Salvini, Italy's deputy prime minister, speaks during a League Party campaign rally with European nationalists ahead of European Parliamentary elections, in Milan, Italy, on Saturday, May 18, 2019.
Bloomberg | Bloomberg | Getty Images

The spread of Italian 10-year debt over top-rated Germany — often used as a fear gauge for Europe by investors —reached approximately 100 basis points between mid-October and mid-March. But it has since widened out to over 285 basis points — that's its lowest level in more than three years.

The euro slipped 0.1% against the U.S. dollar Tuesday afternoon, trading at $1.1187.

Meanwhile, the pan-European Stoxx 600 edged down around 0.2%, dragged lower by Italy's notoriously fragile banking stocks.

Late last year, Italy narrowly avoided an EU disciplinary procedure over its public finances, eventually agreeing to a "borderline" deal with the Commission which the EU executive said at the time was "not ideal."

The Commission is set to review Italy's finances again on June 5.