ROME--Italy's government confirmed it will remain in recession this year, with growth seen picking up next year, as Prime Minister Matteo Renzi readies a new round of economic reforms in the coming weeks, including a major overhaul of labor laws.

In its updated forecasts, the Italian government now sees gross domestic product falling by 0.3% in 2014, below a projection of a 0.4% contraction by the Organization for Economic Cooperation and Development. The government sees GDP growing by just 0.6% in 2015.

The Italian economy slipped back into recession this year, marking the third contraction since 2008, and is also showing the first signs of deflation.

The government confirmed, as expected, that its budget deficit will remain in line or slightly under the 3% of GDP threshold imposed by EU fiscal rules. However, it raised its deficit-to-GDP forecast to 3% for 2014 and 2.9% for 2015, thus freeing up about EUR10 billion in new funding that it wants to use to cut labor taxes and carry forward a reduction in income taxes that it implemented this year.

Italy's debt-to-GDP ratio--the second highest in the eurozone--is seen at 131.7% this year, while rising to 133.4% in 2015. The figures benefit from new accounting rules adopted across Europe that include revenue from illegal activities related to drugs trafficking and prostitution in GDP calculations.

"The macroeconomic environment is very deteriorated from last April, when we issued our previous forecasts," Italy Finance Minister Piercarlo Padoan said Tuesday, adding that Italy will postpone its target to structurally balance the budget--adjusted for the business cycle--to 2017.

The government is under pressure to push through a new round of measures able to kick start growth and reignite foreign investments and is now focusing its efforts on a broad reform of Italy's rigid labor market--so far the major economic overhaul addressed by Mr. Renzi seven-month-old cabinet.

Mr. Renzi aims at getting a parliamentary framework for his so-called JOBS Act approved by the end of the year, but he is facing staunch resistance from the unions and a minority of his center-left Democratic Party. His labor plan aims to tackle the main rigidities of the Italian job market--which tends to protect fixed-term hires while offering new entrants fewer guarantees.

The Italian premier says he wants to streamline the country's huge number of temporary contracts, reducing legal ambiguity for both employers and workers. In line with the International Monetary Fund recommendations, his government has proposed legislation that would progressively introduce a single contract for all new hires, exempting workers from the full welfare protection for the first three years of employment, but progressively increasing protection after that period.

The labor overhaul also aims at expanding unemployment benefits, replacing the state-funded wage guarantee funds with a universal unemployment benefit scheme. But, even though he seemed to be overcoming opposition from within his own party, Mr. Renzi still faces a parliamentary battle to win the guidelines' approval in the Senate, where his government has a weak majority, and may have to rely on the uneasy support of Silvio Berlusconi's center-right party Forza Italia, which stands at the opposition.

The 39-year-old premier, who has to deliver the 2015 budget law by mid-October, is also struggling to find the financial resources needed to fund his bold reform agenda. He has pledged to earmark about EUR20 billion in spending cuts with the new budget, coming mostly from a cut in state expenditures and a renewed push against fiscal evasion.

The Italian premier on Monday promised to use up to EUR2 billion of those savings next year to reduce Italy's labor taxes, which are among the highest in Europe and weigh on small and medium businesses, blocking new hiring. An additional EUR1.5 billion would be used to expand welfare protection for new hires.

Write to Giada Zampano at giada.zampano@wsj.com

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