* S&P says government’s plans bad for GDP growth, debt reduction
* S&P says rising debt yields could crimp bank lending
* Italy PM welcomes no change in rating (Adds details, background)
By Gavin Jones
ROME, Oct 26 (Reuters) - Standard & Poor’s on Friday left Italy’s sovereign debt rating unchanged but lowered its outlook to negative from stable, saying that the new government’s policy plans were weighing on the country’s growth and debt prospects.
S&P left the rating at BBB, two notches above junk, which will come as some relief to the government, which is locked in a tussle with the European Commission over its 2019 budget and last week saw its debt downgraded by Moody’s.
However, S&P delivered tough criticism, saying that next year’s fiscal deficit will exceed Rome’s target and that the public debt will not come down as planned.
“The Italian government’s economic and fiscal policy settings are weighing on the country’s economic growth prospects, a critical driver of government debt-to-GDP trajectory,” S&P said.
“In our view, the government’s planned economic and fiscal policy settings have eroded investor confidence, as reflected by a rising yield on government debt,” it said, warning of possible problems for the country’s banks, which hold a large amount of Italian government bonds.
If the yields on the banks’ sovereign bond holdings continue to rise, it could reduce their capacity to fund the economy, the ratings agency said.
The European Commission on Tuesday rejected Italy’s draft 2019 budget and asked Rome to submit a new one within three weeks.
The budget targets a fiscal deficit next year of 2.4 percent of gross domestic product, up from a targeted 1.8 percent this year, flouting an EU requirement that the deficit should fall steadily towards a balanced budget.
S&P forecast the 2019 budget deficit at 2.7 percent of GDP and said Italy’s huge public debt, which stood at 131.2 percent of GDP last year, would remain stable at around 128.5 percent for the next three years.
It also said the coalition government’s forecasts for economic growth of 1.5 percent next year and 1.6 percent in 2020 were “overly optimistic,” and lowered its own forecasts to 1.1 percent from 1.4 percent for both years.
“We expect the demand stimulus from the government’s budgetary measures will likely be short-lived,” S&P said.
Deputy Prime Minister Matteo Salvini dismissed S&P’s report as “the same old film” and threw doubt on the credibility of ratings agencies which “didn’t notice the financial crisis.”
Prime Minister Giuseppe Conte said the fact the agency had left Italy’s rating unchanged was “correct in view of our country’s economic solidity.”
Earlier on Friday, Salvini said the government would not backtrack on the budget “even by half a millimetre,” ramming home a message expressed by other ministers in the coalition which took office in June
S&P took particular aim at the government’s plan to lower the retirement age, saying that if fully implemented the policy will “threaten the long-term sustainability of public finances.”
On the positive side, it said Italy “continues to be supported by its wealthy and diversified economy and its strong external position, with the economy close to becoming a net creditor in the context of its net international investment position.”
S&P said it did not expect the government to question Italy’s membership of the euro zone.
This issue has arisen frequently due to the eurosceptic views of some prominent coalition members, despite the government’s regular assurances that it has no intentions of quitting the single currency. (Reporting by Gavin Jones; Editing by Hugh Lawson and Leslie Adler)