Italy should not ignore damage to banks from soaring bond yields, official tells paper

MILAN (Reuters) - Italy's government should not ignore the problems that soaring government bond yields are causing for Italian banks, including possible capital needs, Cabinet Undersecretary Giancarlo Giorgetti said in a newspaper interview on Sunday.

Giorgetti also told Italian daily Il Messaggero that next year's budget deficit may turn out to be lower than the proposed 2.4 percent of gross domestic output.

The profligate budget plans of Italy's populist government have prompted investors to shed 67 billion euros ($77 billion) of Italian government bonds since May, sending the yield premium Italy pays over safer German paper to more than 3 percentage points.

"The increase in the (bond yield) spread, the amount of public debt banks hold and new European Union banking rules put the industry under pressure and may generate the need to recapitalise the most fragile lenders," said Giorgetti, who is an influential member of the far right League, one of the two parties in Italy's ruling coalition.

Italian banks had been raising capital in recent years to restructure after a deep recession that turned almost a fifth of all bank loans sour.

The clean-up was just beginning to bear fruit when lenders were hit by a spike in Italy's debt costs, which hurts the value of their large sovereign holdings, eating into their capital.

Pummelled by investors, Italian banks' shares trade at a fraction of the value of their assets but the growing uncertainty over Italy's prospects would make it hard for them to raise capital.

"We can't just pretend nothing is happening and ignore these problems," Giorgetti said.

He said the government was made up of "responsible people who would do things responsibly."

After initially rebuffing criticism from Brussels over a sharp deficit increase in the draft 2019 budget, which the European Commission has labelled an "unprecedented" breach of EU fiscal rules, Italy appeared to have softened its stance.

On Saturday, Prime Minister Giuseppe Conte said Rome wanted to establish a "constructive dialogue" with the EU over the budget because it recognised the role of European institutions.

"The 2.4 percent figure is a ceiling for all the various measures included in the budget, but it's not a given that all of them can be implemented because there could be technical difficulties," Giorgetti said.

The coalition comprising the League and the anti-establishment 5-Star Movement wants to boost deficit-spending to lower the retirement age and provide a basic income for the poor.

(Reporting by Valentina Za; Editing by Raissa Kasolowsky)