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UPDATE 3-EU prepares the ground for disciplinary procedure over Italy debt

Francesco Guarascio and Jan Strupczewski

* EU Commission says procedure against Rome is warranted

* If started in next weeks, procedure could lead to sanctions

* Brussels open to changing analysis if Italy makes commitments

* IMF sees Italy's debt as major risk to euro zone (adds details, quotes)

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.

The move paves the way for the actual opening of the proceedings next month, but Brussels insisted that the process could be blocked if Rome made sufficient fiscal commitments.

Italy averted the same procedure in December after a last-minute deal with the Commission in which Rome committed to a lower deficit this year - but Italian government officials now seem less prone to compromise after EU Parliament elections in May gave co-ruling far-right League a resounding win.

"To be clear, today we are not opening a procedure," the EU commissioner for the euro Valdis Dombrovskis told a news conference, noting that other steps would need to be taken before the formal beginning of the process.

European Union states would have to back the Commission's assessment that a procedure is warranted in the next two weeks. After that, Brussels could recommend to start the procedure, a step that could come before a meeting of EU finance ministers in early July. This is the expected timeline:.

"My door is open" to change the analysis if Italy makes new commitments, the EU economics commissioner Pierre Moscovici said .

If started, the procedure could lead to unprecedented financial sanctions. Although fines remain unlikely, the fiscal fight with Brussels exposes Rome to increased market pressure.

Italian sovereign bond prices and bank stocks fell after the Commission issued its opinion on Wednesday.

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.


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:

The International Monetary Fund identified Italy's debt as a major risk to the euro zone economy, along with global trade strains and a hard Brexit, an EU document showed, anticipating a report the IMF will present next week.

The EU 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 interest on its debt, "as much as for the entire education system," 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 privatization plan will have no impact on Italy's growth, in contrast with Rome's more optimistic estimates.

The Commission report also said Italy had made limited progress in addressing EU economic recommendations and backtracked on necessary structural reforms, such as a pension reform that Italy's eurosceptic government softened, extending chances for early retirement. This "may negatively affect Italy's growth potential," the Commission said. (Reporting by Francesco Guarascio zfraguarascio and Jan Strupczewski; Editing by Robin Emmott, William Maclean)