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UPDATE 1-Italy unlikely to set new 2020 deficit goal in EU budget tussle - government source

Giuseppe Fonte

government source@

* EU Commission has threatened Italy with disciplinary procedure

* Italy to cut 2019 deficit to 2.0 or 2.1% of GDP

* Coalition doesn't want to commit to new 2020 target

* Conte hopes to make progress on deal with EU at G20 (Adds details, Q1 deficit date, background)

ROME, June 26 (Reuters) - Italy aims to clinch a deal with the European Commission over its contested public finances without setting a new goal for next year's budget deficit, a senior government source told Reuters.

The Commission has threatened Rome with a disciplinary procedure because it failed to cut its large public debt in 2018 as promised, and the Commission forecasts the debt will also rise this year and next.

The procedure, which has not yet been launched and would have to be approved by euro zone finance ministers, would entail closer oversight of Italy's fiscal policy and could eventually lead to fines.

The government will cut this year's deficit target in the next few days to 2.0% or 2.1% of gross domestic product from a 2.4% goal set in April, and hopes this will go a long way to satisfying the Commission, said the source who asked not to be named.

The main reason for the positive trend is that two flagship government measures - an early retirement option and a new means-tested welfare benefit - are proving less popular, and therefore less costly, than expected.

For next year, the coalition of the anti-establishment 5-Star Movement and the right-wing League is reluctant to commit to a new target, but will instead promise to cut public spending and scrap many existing tax breaks, the source said.

The government will also commit to finding alternative cuts or revenues in order to avoid a scheduled rise in sales tax due to kick in next year.

The current deficit goal for 2020 stands at 2.1% of GDP.

Brussels is likely to want that reduced so that the deficit follows a declining trend towards a balanced budget, as EU rules require.

However, League leader Matteo Salvini and 5-Star chief Luigi Di Maio do not want to tie their hands to a goal which would make it harder to fulfil their promises of tax cuts next year.

Instead, both leaders have said they are prepared to fund their pledges by raising the deficit if necessary.

Italy would not normally have to set a new deficit target for next year until September, just before it presents its 2020 budget the following month.

Salvini and Di Maio argue that by boosting economic growth the public debt can still fall as a proportion of gross domestic product even with a rising budget deficit.

At some 132% of GDP, Italy's debt is proportionally the highest in the euro zone after Greece's.

Prime Minister Giuseppe Conte expects to make progress towards a deal with the EU in talks with Commission President Jean-Claude Juncker at a G20 meeting in Osaka, Japan, this week, two government sources said.

Data earlier on Wednesday showed the deficit in the first quarter narrowed marginally to 4.1% of gross domestic product, compared with 4.2% in the same period of 2018.

The deficit is normally comparatively high in the first quarter of each year, and lower later in the year thanks to tax return deadlines. Over the whole of last year the deficit amounted to 2.1%. (Reporting by Giuseppe Fonte; Writing by Gavin Jones; Editing by Alison Williams)