Italian Prime Minister, Mr Romano Prodi yesterday hailed Italy's "half point of happiness" rate cuts as a vote of confidence in his government's economic grit. As Bank of Italy governor, Mr Antonio Fazio cited mild inflation as a key reason why he slashed interest rates, fresh data showed consumer prices subdued and stoked expectations of more cuts.

Italians toasted the surprise half-percentage-point official rate reductions as the latest sign they were steaming towards the launch of European Economic and Monetary Union. RAI state television trumpeted the rate cut as a "half point of happiness", and daily La Repubblica reflected that it was a fine gift for Mr Prodi, whose government yesterday became Italy's third-longest administration since the second World War.

"The Bank of Italy has recognised that our commitment to create the conditions for the lowering of (interest rates) has been maintained," Mr Prodi said. The easing, which reduced the cost of money to a 26-year low, would fuel investment in the coming months, he said.

As Mr Fazio basked in praise for his timing, he complimented Mr Prodi's centre-left government for its budgetary efforts, saying its recently unveiled three-year economic plan moved in the right direction.

Financial markets initially joined the party, with the yield gap between 10-year Italian and German debt snapping to a record low and the Mibtel all-share index leaping 1.79 per cent at the open.

But both markets had lost their shine by the close, hobbling into negative territory as profit-takers traded on disappointment the rate reduction had not been bigger.

Analysts estimate Tuesday's cut will translate into savings of some 10 trillion lire ($5.7 billion) in the cost of servicing Italy's towering debt over the long term.

At 121.6 per cent of gross domestic product in 1997, public debt is more than double the 60 per cent target for EMU membership, on which Italy has staked all its hopes.

The discount rate now stands at 5.0 per cent, with the fixed term advances, or Lombard, rate at 6.5 per cent.

"The cut in the discount rate was justified by the trend of the markets inside and outside Italy, and by the trend of current and expected inflation," Mr Fazio said.

The final four of Italy's 11 sample cities released their consumer price data yesterday, indicating a provisional annual inflation rate of 1.7 or 1.8 per cent, analysts said. The rate was 1.7 per cent in March.

Though easing had been universally expected, the timing surprised a market which had been betting on a rate move around the time of the May EU summit, when European leaders will formally decide who will launch the euro on January 1st.

Mr Fazio, who has consistently held fire on rate cuts even when financial markets were screaming for a move, said it was necessary to balance the budget faster to ensure Italy complied fully with EMU criteria and could withstand any economic shocks.

A letter from Mr Prodi to the European Commission made public on Tuesday, saying the governing coalition was firmly united behind the economic plan, was thought to have been one of the factors convincing the Bank of Italy that the time was right.

As well as the subdued inflation data, the lira's position near its parity in the European Exchange Rate Mechanism, plus news from Luxembourg that EU finance ministers would not seek further commitments from Italy, were also seen as key factors.

The market is now on red alert for further cuts but Mr Prodi steered clear of any rates predictions.

"Let's be content with what has happened and then we'll see," he said.