Three key dates for Italy's 'Hot Autumn'

By Dhara Ranasinghe, Ritvik Carvalho and Danilo Masoni

LONDON/MILAN (Reuters) - Italian stock and bond markets, recovering from a torrid spring selloff, will be put to the test again during an event-risk-packed September and October that local media have dubbed "Autunno Caldo" -- hot autumn.

Talks on the 2019 budget that could put Rome on collision course with the European Commission given the anti-establishment coalition's big-spending plans, should keep markets in a state of heightened sensitivity to politics.

And while a semblance of calm has returned recently to Italian markets, sentiment can turn quickly, as a May rout proved. Two-year bond yields spiked over 180 basis points on May 29, their biggest one-day jump in 26 years, while bank shares tanked 23 percent in less than two weeks.

"It all comes to a head in the autumn because this will be the government's first budget," said Rabobank rates strategist Matt Cairns.

"They need a middle ground - something that pleases the electorate and doesn't shock the market."

At stake are Italy's borrowing costs -- already well above most European peers. Second, higher yields pose risks to Italian banks, which own almost a fifth of the nearly two trillion euros (£1.8 trillion) of outstanding government debt.

The May bond selloff is estimated to have inflicted an average 40-50 bp hit to banks' capital ratios in the second quarter.

GRAPHIC - Higher risk premium priced into Italian debt: https://reut.rs/2LZw1sa

Here are the three event risks in focus:

1/ RATINGS CENTRAL

On Sept. 7, Moody's could downgrade its Baa2 rating on Italy which is on review for such a move. Fitch reviews Italy on Aug. 31 and S&P Global on Oct. 26.

A downgrade would not cost Italy its investment grade rating, crucial to flagship bond indexes, but would likely put further upward pressure on government borrowing costs.

Above all, it would be a setback for Italy which last October earned its first S&P ratings upgrade in at least three decades.

GRAPHIC - Italy's sovereign ratings: https://reut.rs/2O4Ag2L

2/ MIND THE (BUDGET) GAP

On Sept. 27, Italy releases its Economic and Financial Document. A precursor to the 2019 budget, it will offer an indication of the planned fiscal deficit.

The previous government had promised a deficit of 1.6 percent of GDP this year and 0.8 percent in 2019, versus 2.3 percent last year.

GRAPHIC - Italy's budget deficit set to test EU rules?: https://reut.rs/2n8vpCq

If fully implemented, the spending plans could cost 5 to 6 percentage points of GDP, economists reckon.

Such a spending spree would raise fears about Italy's debt sustainability and its commitment to the euro, as bloc members are required to stick to a maximum 3 percent budget deficit.

GRAPHIC - Where next for Italy's debt levels?: https://reut.rs/2KmGDwe

3/ DRAFT BUDGET DAY

Italy must submit a draft budget to the European Commission on Oct. 15. This could be rejected if it does not comply with EU fiscal discipline rules. EU agreement is needed before Italy's parliament can approve the budget.

"They can probably get away with a one percentage point of GDP fiscal expansion," said Hetal Mehta, senior European economist at Legal and General Investment Management.

"To some extent, Europe would turn a blind eye to that ... to take the other extreme, something along the lines of more than 3 percent would be deemed as a very bad budget."

graphic - Italian banks left exposed to any sovereign bond shock: https://reut.rs/2MeYR4q

(Reporting by Dhara Ranasinghe in London and Danilo Masoni in Milan; Additional reporting by Crisipian Balmer in Rome; Graphics by Ritvik Carvalho; Editing by Robin Pomeroy)