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UPDATE 2-Bank of Italy warns public debt could rise more than forecast this year

Stefano Bernabei and Giuseppe Fonte

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ROME, May 31 (Reuters) - The Bank of Italy warned on Friday that the country's $2.6 trillion of debt may swell this year by more than the government forecasts and called for "credible" measures to curb it.

Concerns over Italy's public finances have driven up Rome's debt costs since a populist government took power a year ago.

The central bank's warnings pushed up the risk premium Italian bonds pay compared with safer German debt to its highest since December, at almost three percentage points.

"The tensions in Italy's government bond market are curbing growth prospects," Bank of Italy Governor Ignazio Visco said in the text of a speech prepared for the central bank's annual meeting.

Visco said at the end of the year debt as a percentage of gross domestic product year could top the 132.6 percent forecast set in the budget, which relies on the government managing to raise 18 billion euros from privatisations.

Italy pocketed 60 million euros from privatisations in 2017-2018, missing a yearly target of 5 billion euros, Bank of Italy data showed. Italy's debt-to-GDP ratio, second only to Greece's within the euro zone, has risen from a pre-crisis low of below 104% hit in 2007 to 132.2 percent at the end of last year.

"The high debt-to-GDP ratio continues to be a severe constraint," Visco said. "There must be no delay in defining a rigorous and credible strategy for its reduction in the medium term."

Visco urged the government to find offsetting measures if it wanted to keep good on a pledge to avoid a scheduled increase in the sales tax.

Freezing the sales tax hike without countermeasures "would be incompatible with a reduction in the debt-to-GDP ratio."

The government currently targets a 2.1 % deficit-to GDP-ratio for 2020, including some 23 billion euros from sales tax hikes due to take effect next year.

Visco said that running higher state deficits in an attempt to provide a "temporary relief" for Italy's stagnating economy could prove "less than effective, even counterproductive" if it ended up hurting confidence.

Emboldened by a victory in last week's vote for the European parliament, League leader Matteo Salvini has made a priority of reducing Italians' high tax burden by introducing a single tax rate.

A senior source within the ruling 5-Star Movement told Reuters on Friday they backed the League's to fund the "flat tax" measures through a higher budget deficit. (Reporting by Stefano Bernabei, Giuseppe Fonte; editing by Valentina Za, Larry King and Raissa Kasolowsky)