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UPDATE 2-EU Commission says disciplinary procedure over Italy debt is justified

Francesco Guarascio and Jan Strupczewski

justified@ (adds quotes, details)

BRUSSELS, June 5 (Reuters) - The European Commission concluded on Wednesday that Italy is in breach of EU fiscal rules because of its growing debt, a situation that justifies the launch of a disciplinary procedure.

If European Union states back this assessment in the next two weeks, the EU executive could subsequently recommend to start the procedure, a move expected before a meeting of EU finance ministers in early July. This is the expected timeline: .

The Commission said Italy had made limited progress in addressing EU economic recommendations and backtracked on necessary structural reforms.

This "may negatively affect Italy's growth potential," the Commission said.

Italy's public debt, the second highest in the EU in proportion to output after Greece's, rose from 131.4% of gross domestic product (GDP) in 2017 to 132.2% in 2018 and the Commission estimates that it will go up to 133.7% this year and to 135.2% in 2020, in breach of EU rules that say it should go down.

Here an overview of public debt in EU states: https://graphics.reuters.com/PORTUGAL-FINANCE-MINISTER/010051JT3H1/index.html

Separately, the International Monetary Fund has identified Italy's debt as a major risk to the euro zone economy, together with global trade tensions and a hard Brexit, an EU document seen by Reuters showed on Wednesday, anticipating a report the IMF will present next week.

The Commission is in charge of monitoring EU countries' budgets and is obliged to publish reports on states which appear to deviate from agreed fiscal targets.

The Commission said the debt is growing because interest rates Italy has to pay to service it are increasing more than the country's growth rate.

Brussels estimates that Italy paid last year 65 billion euros ($73.3 billion) in interests over its debt, "as much as for the entire education system," the EU commissioner for the euro Valdis Dombrovskis said.

The Commission's forecasts are more pessimistic than Italy's estimates. Rome expects the debt to rise this year to 132.6% of output, and decline to 131.3% in 2020.

The difference is mostly due to the fact that the Commission is not including in its forecasts a hike in sales tax next year, which Italian government's officials have repeatedly said they will try to avoid despite revenues from the tax hike are already included in Rome's economic forecasts.

The Commission also estimates that a planned privatisation plan will have no impact on Italy's growth, in contrast with Rome's more optimistic estimates.

Italian sovereign bond prices and bank stocks fell further after the Commission issued its conclusion.

Italian banks .FTIT8300 were down nearly 1.8% to a day low by 1039 GMT following the news, while the yield on 10-year government bonds rose five basis points to hit the day's high at 2.575%. IT10YT=RR. (Reporting by Francesco Guarascio zfraguarascio and Jan Strupczewski; Editing by Robin Emmott, William Maclean)