By Danilo Masoni
MILAN (Reuters) - European shares dipped on Friday after the Italian government agreed to set a higher than expected budget deficit target that could put Rome on a collision course with Brussels.
Shares in Italian banks (FTIT8300), whose big sovereign bond portfolios makes them sensitive to political risk, bore the brunt of selling pressure, fell 4.5 percent, while government bonds sold off and the focus turned to rating agencies.
The pan-European STOXX 600 (STOXX) index was down 0.4 percent by 0759 GMT but was still on track for a small weekly gain, its third in a row. Italy's FTSE MIB (FTMIB) index fell 2.4 percent, while Germany's DAX (GDAXI) fell 0.8 percent.
"The deficit number is higher than expected and that clearly is not a good sign. All the attention will now shift to rating agencies which were waiting for the budget to reconsider their scorings," said Gilles Guibout, portfolio manager at AXA IM in Paris.
"Meanwhile, it's difficult to imagine that Italian stocks will perform well," he added.
Italy's government on Thursday targeted the budget deficit at 2.4 percent of gross domestic product for the next three years, defying Brussels and marking a victory for party chiefs over economy minister Giovanni Tria, an unaffiliated technocrat.
Financials weighed heavily on the STOXX 600, dragged down by losses among Italian banks. Euro zone banks (SX7E) fell 2.3 percent.
Analysts at Credit Suisse (SIX:CSGN) led by Carlo Tommaselli said Italy's deficit target at 2.4 percent of GDP was not the worst case scenario for markets but still posed some issues.
"The key point is that the higher than expected deficit is addressed to finance new expenses rather than growth," they wrote in a note, adding that action from rating agencies was now crucial for the country's banks stocks.
"A potential downgrade of the country rating could pose risks to the sovereign investment grade and additional potential charges to CET1 ratios which nevertheless would be mitigated by the internal models which most of the Italian banks adopt," they added.
Shares in Italy's two largest banks, Intesa Sanpaolo (MI:ISP) and UniCredit (MI:CRDI), both fell more than 4 percent, while smaller lenders such as Banco BPM and UBI were also under heavy selling pressure. Postal group Poste Italiane (MI:PST), which holds 130 billion euros of Italian government bonds, fell 4.7 percent.
Elsewhere, BASF (DE:BASFn) fell 2.4 percent after the chemicals group agreed to combine its oil and gas businesses Wintershall with DEA to create an independent European oil and gas company. BASF also said demand was slower than initially expected in the third quarter.
RSA Insurance (L:RSA) reported a small rise in net written premiums for the year so far, but said higher weather losses in Britain led to a disappointing third quarter. Its shares fell 7.9 percent.
Losses on the broader European market were limited by gains among some defensive healthcare and consumer stocks.
Swedish aerospace company Saab (ST:SAABb) rallied 7.3 percent boosted by news its partner Boeing (NYSE:BA) had won a $9.2 billion contract with the U.S. Air Force.