The Italian government halted foreign exchange trading in the lira today after the currency plunged nearly 20 percent against the U.S. dollar and significantly against several other currencies, including the West German mark.

The lira partially recovered its losses later in the day in limited trading on other foreign exchange markets. Traders said they expect an official lira devaluation of about 5 percent to be agreed upon this weekend at a meeting of the European Monetary System in Basel, Switzerland.

The relative currency values within the EMS have not been adjusted for more than two years, and Italian officials have been arguing for a devaluation to help correct a growing trade deficit.

Foreign exchange traders said that there were indications that the Bank of Italy had been working with Italian commercial banks to set the stage for letting the market "force" a devaluation. Today, when a commercial order arrived at the Milan foreign exchange market to sell a reported $150 million worth of lira, the Bank of Italy failed to intervene as it usually does to support the Italian currency. There was a panic in which traders dumped lira, and its value fell from 1,840 to a dollar to 2,200, a 19.5 percent decline, when the Milan exchange was shut at about 1:30 p.m. local time.

[Later in the day, only a few institutions outside Italy were willing to trade the currency. In Boston, the State Street Bank & Trust Co. was selling lira at 1,925 to the dollar and buying them at 2,000 to the dollar, a trader there said. Normally, the spread in such interbank transactions is 1 lira or less, not the 50 to 100 that prevailed in the afternoon, he said.]

A government official, Treasury Minister Giovanni Goria, said today that the hike in the dollar's value was a "regrettable" technical incident stemming from unexpected massive dollar orders "at any price" at a time when the Bank of Italy had decided not to intervene.

But some economists said they believed the surge was the result of deliberate speculative moves by groups concerned about Italy's weakening competitive position and eager for a lira lower in value.

Earlier this week, Italy's Socialist Prime Minister Bettino Craxi said in a major government economic statement that some "exchange rate adjustments" might be necessary to shore up the Italian currency, which is threatened by the unchecked growth of the state budget and its deficit, ongoing inflation and falling exports. Economists believe that Italy could run a trade deficit of more than $11 billion this year.

These same economic problems have been pushing Italy's five-party coalition government toward a choice between substantial spending cuts and a new round of price and tax hikes. After several days of debate within the cabinet, the government decided this week to hold off on increases of some prices and indirect taxes until after the summer to avoid refueling inflation.

In a 15-page document released to the press two weeks ago, Luigi Lucchini, the head of Confindustria, the Italian national manufacturers' association, called for "blood, sweat and tears" from the government and ruling political parties.

Lucchini said "courageous and structural measures" by the government were needed to provide Italy with "more competitiveness, more development and more employment." He pointed out that, while labor costs had increased significantly more than they had for Italy's chief competitors during the first part of 1985, productivity had declined by 12 percent compared with West Germany and France, and by 18 percent compared with Great Britain. Indeed, statistics show that the effects of a much-welcomed 1984 economic recovery have begun fading rapidly.

For Italy, the world's seventh-most-industrialized nation, 1984 brought a 2.8 percent jump in gross domestic product -- a better showing than any other major European country -- and an end to a three-year recession. Productivity grew by 5 percent last year, real wages were stationary, and inflation fell below double-digit levels for the first time in more than a decade, thanks largely to modifications of the wage-indexation system and a drop in demand for imported products.

With half of 1985 gone, however, it is clear that the picture has darkened. Inflation, which in November had fallen to 8.6 percent, has not improved, and economists here now say the government is unlikely to meet its 7 percent target for the end of the year.

The spurt in growth last year was insufficient to offset unemployment, which now stands at an average of 10.5 percent, with a peak of 33 percent for job seekers under 29.

Last year, the debt -- widely believed to be the major cause of inflation -- was about $53 billion, equal to 15.2 percent of gross domestic product. It is expected to increase again this year, and a deficit of $2.7 billion is anticipated.

Political sources here said cutting government spending for social services, health or pensions would be extremely difficult. But raising prices or taxes would be equally painful. Sources said the most likely measure is a 100-lire (5-cent) increase in the price of gasoline. A hike in postal rates and the price of pharmaceuticals also is expected.