By Francesca Landini and Luca Trogni
MILAN (Reuters) - A deeper-than-expected recession will force Italy to sell more bonds and bills this year than planned, a senior Treasury official said, presenting an even steeper funding challenge for the world's fourth-biggest debtor.
In an interview with Reuters on Tuesday, Treasury Debt Management Office head Maria Cannata said Italy has upped its gross funding target for 2012 to 460-465 billion euros from a previous forecast of 440-450 billion euros.
The decision comes after the Italian government slashed its growth forecasts for this year and next in September and hiked its deficit and debt estimates.
"We will issue roughly 20 billion euros more than previously targeted as state borrowing requirements for 2012 have been revised due to the weakening economy," Cannata told Reuters.
Rome has forecast that gross domestic product will shrink this year by 2.4 percent, twice as much as the 1.2 percent drop it projected as recently as April.
The recession is hurting Italy's fiscal consolidation efforts due to lower tax revenues and higher welfare expenses.
The Treasury has managed to issue around 370 billion euros in debt so far this year despite a turbulent conditions in euro zone markets, Reuters calculations show. But it faces another busy quarter given its revised funding target and heavy redemptions at the end of 2012.
"We will not cancel any debt auction scheduled in December," said Cannata, who manages Italy's 2 trillion euro debt.
October debt redemptions will be around 37 billion euros, with 56 billion euros of bonds and bills maturing in December.
The launch next week of a new sale of four-year, inflation-linked BTP Italia bonds should help Rome draw much-needed retail demand. Small investors will be able to buy the bond online from October 15 until October 18, just as a large amount of bills and a five-year bond are due to be repaid.
The Treasury will announce on Friday the minimum yield for the bond, which protects investors from rising Italian prices.
"I am confident the new BTP Italia will be well received by investors thanks to the timing of this issue," Cannata said.
The Treasury sold a hefty 7.3 billion euros of similar inflation-linked bonds to retail buyers in March, but a second sale in June raised just 1.7 billion euros as seasonal tax payments hit demand.
Foreign investors have mostly retreated from the Italian debt market but Cannata said they have started to tiptoe back after the European Central Bank pledged last month to buy bonds of weaker euro zone countries.
"The ECB's commitment to buy bonds for an unlimited amount has brought back confidence. However for the Italian-German bond yield spread to tighten further, we will have to see more progress by policymakers towards an EU banking union," she said.
The yield on Italy's 10-year benchmark bond is currently around 360 basis points more than for its German equivalent. That premium that has shrunk from 520 basis points on July 26, the day ECB head Mario Draghi hinted for the first time at the new scheme to buy bonds.
Draghi laid out details of the ECB intervention scheme on September 6, consolidating a rebound in peripheral euro zone debt.
"We have seen a comeback of foreign buyers," Cannata said. "At the beginning of September they were mainly interested in the 2-to-3 year segment of the yield curve. More recently, they have started moving towards five- and 10-year bonds."
A solid return of foreign demand would be a turning point for Italy, which is currently relying on domestic buyers and has had to steer towards short-dated maturities to lure investors.
The average life of Italian debt is forecast to be around 6.7 years by the end of 2012, slightly down from around 7 years in 2011. But the trend may reverse in 2013.
"In 2013 redemptions will be less heavy and more evenly spread. This should let us reduce net issuance of short-dated debt next year in comparison with 2012."
(Editing by Catherine Evans)