* Brussels downgrades could reignite budget dispute
* Says Italy economy to grow 0.1 pct this year, lagging bloc
* EU says debt, deficit to rise
* Italy says forecasts "ungenerous", "prejudiced" (Recasts after Conte comments)
By Francesco Guarascio and Giancarlo Navach
BRUSSELS/MILAN, May 7 (Reuters) - Italy accused EU authorities of prejudice on Tuesday after they forecast the euro zone's third largest economy would stagnate this year and its huge public debt would rise further.
The European Commission cut its growth prediction for Italy and said its public finances would deteriorate further, in an assessment that could reignite a dispute with Rome over its budget after the two sides reached an uneasy compromise in December.
Italian Prime Minister Giuseppe Conte said the forecasts were ungenerous and "prejudiced," because they assumed Italy would post no further growth this year after it emerged from recession with a stronger-than-expected first quarter.
Brussels marginally cut its 2019 growth outlook for Italy to 0.1 percent from an already gloomy 0.2 percent.
The commission also forecast growth in the wider euro zone economy to slow more than previously estimated, to 1.2 percent.
But its prediction for Italy is the lowest in the bloc, and the Commission said it expected that to weigh on debt and deficit, which were both seen climbing above levels previously agreed with Brussels.
The Commission's forecasts were drawn up before data showed Italy posted first quarter growth of 0.2 percent, and the government says its policies to raise welfare benefits will support domestic demand.
Conte told reporters in Milan he expected "solid growth" in the second half of the year.
Rome has forecast growth of 0.2 percent this year and 0.8 percent in 2020, 0.1 percentage points above the Commission for each year, but after the first quarter data Economy Minister Giovanni Tria said he thought this year's target could be exceeded.
Tria told reporters in Paris the Commission's public finance projections for next year were "more political than economic", because they took no account of the government's commitments to reduce the deficit in its 2020 budget.
Although no EU decision over possible disciplinary moves is expected before European elections on May 23-26, the more downbeat estimates could increase market pressure on a coalition government in Rome already plagued by infighting.
Milan shares fell after the Commission's forecasts were published and the yield gap widened between Italian government bonds and safer German Bunds.
The Commission - which came close to penalising Italy over an excessive deficit target before the agreement in December - will assess states' compliance with EU rules at the beginning of June, economics commissioner Pierre Moscovici said.
Without policy changes, Italy's deficit would be 2.5 percent of gross domestic product (GDP) this year, the commission said, lowering a 2.9 percent forecast it made in November. The bloc's executive forecast the deficit would climb to 3.5 percent in 2020, beyond the EU's 3.0 percent ceiling.
The government has targeted a deficit of 2.4 percent this year and 2.1 percent in 2020.
The commission expects Italy's debt to grow to 133.7 percent of GDP this year and peak at 135.2 percent in 2020, while Rome is targeting 132.6 percent this year and 131.3 percent in 2020.
Euro zone countries with a debt rate above 60 percent are required to gradually reduce it. But Italy's has been growing since last year, when it cost 3.7 percent of economic output to service.
With Italian bond yields having dropped slightly after December's budget deal with Brussels, interest expenditure is forecast to drop to 3.6 percent of GDP this year, before rising again in 2020.
The structural deficit, which excludes one-off items and the effects of the business cycle, is also expected to worsen. This indicator is crucial in the EU assessment over countries' compliance with fiscal rules. The primary surplus, which excludes interest payments, is expected to ease.
Italy is the only euro zone country in which the commission expects employment to fall this year, by 0.1 percent, even though the first quarter showed firm job growth. Brussels also singled out Italy as the only state where investments will fall, by an estimated 0.3 percent. (Additional reporting by Gavin Jones in Rome and Leigh Thomas in Paris; editing by Robin Emmott and John Stonestreet)