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FILE PHOTO: Newly appointed Italian Prime Minister Giuseppe Conte shakes hands with undersecretary for Prime Minister Giancarlo Giorgetti at Chigi palace in Rome, Italy, June 1, 2018. REUTERS/Alessandro Bianchi/File Photo

(reuters_tickers)

By Steve Scherer and Silvia Ognibene

ROME/MARINA DI PIETRASANTA, Italy (Reuters) - Italy's populist government could break European Union fiscal rules next year with a big-spending budget, a cabinet official said on Friday, despite Brussels calling for a "prudent" spending plan and new data showing feeble economic growth.

Cabinet undersecretary Giancarlo Giorgetti said a need to invest heavily in infrastructure could justify a 2019 deficit of more than 3 percent of gross domestic product, the maximum allowed under EU rules designed to ensure financial stability.

His comment sent a shiver through Italy's sovereign bond market, propelling two-year yields to three-month highs and underlining investor concerns that a nation with the euro zone's second largest debt burden could go on a major spending spree.

The state of Italy's roads, bridges, schools and other public buildings have come under scrutiny since a viaduct collapsed in Genoa this month, killing 43 people. The disaster revived concerns about ageing infrastructure nationwide.

"It's not just bridges but schools and public buildings," Giorgetti said on the sidelines of a conference in the Tuscan town of Marina di Pietrasanta, when asked if the government could exceed the 3 percent limit.

"We must table with Europe a serious negotiation on this," he added. "If exceeding the 3 percent ceiling is necessary to ensure safety in this country, then yes."

Italy has a debt burden of about 130 percent of GDP, and is a chronic underperformer in the euro zone. Its economy is still around six percent smaller than it was at the start of 2008.

On Friday, economic data for July did little to ease market nerves, despite a fall in the unemployment rate to 10.4 percent, its lowest level in more than six years.

The euro zone's third biggest economy grew 0.2 percent in the second quarter, in line with market forecasts for annual growth to slow to 1.2-1.4 percent this year and weaken further in 2019. Growth last year was 1.5 percent. [R1N1C401T]

WAITING FOR FITCH

Morale among Italian manufacturers stands at its lowest level in almost two years, and consumer morale has also declined, according to data released this week.

But economist Stefania Tomasini, of research house Prometeia, said there had not been a dramatic worsening of expectations despite the recent market volatility.

"We need to see what will be in the 2019 budget and how it will be received," she said.

Markets are also awaiting an assessment of Italy's creditworthiness by credit rating agency Fitch, which is due to announce its decision late on Friday. It puts the sovereign rating at BBB, near the bottom of investment grade.

Investors do not expect a rating cut, but fear Fitch will downgrade its outlook to negative from stable.

The European Commission, which must sign off on Italy's next budget, has warned the anti-establishment government that it expects a "substantial effort" on the upcoming budget, which must be submitted to Brussels for approval by end-October.

"It is in the interest of Italy to control public debt," European Commissioner for Economic and Financial Affairs Pierre Moscovici told the financial newspaper Il Sole 24 Ore on Friday.

He encouraged Rome to work towards a "prudent budget which respects commitments and minimises risks".

As the market pressures build, a few government officials have voiced fears of a speculative attack on the bond market. The difference between yields on Italian bonds and German debt, which is seen as safer, is worryingly close to a five-year high.

The 5-Star Movement, which rules in coalition with the right-wing League, is pushing for a 2019 budget deficit of 2.9 percent, near double what Economy Minister Giovanni Tria is prepared to accept, Italian newspapers said on Friday.

Tria, an academic with links to the centre-right, is prepared to go to at least 1.5 percent, compared with the previous administration's limit of 0.9 percent, but not much further for fear of spooking markets, La Stampa said.

The coalition came to office three months ago promising a massive stimulus programme of tax cuts, easier pension rules and a minimum income for the poor, raising eyebrows in Brussels.

(Additional reporting by Elvia Pollina and Giulia Segreti in MILAN; Writing by Mark Bendeich; Editing by Mark Heinrich)

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Reuters