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Italy: the longest recession on record may get even longer

Economic Update

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The 13Q1 GDP release showed that economic activity contracted for the seventh quarter in a row, making this the longest recession on record. The breakdown revealed that only inventory formation contributed positively to growth while government consumption was flat. We expect output to fall once again in Q2, but at a more moderate pace. Hard data such as industrial production, manufacturing orders and retail sales support this view. Unfortunately, leading indicators are sending mixed signals, which makes it difficult to determine the pace of underlying momentum going forward. A further rise in Italian bond yields can bring debt sustainability concerns to the fore and delay the recovery.

Year-on-year change (%)

Source: Reuters EcoWin, Rabobank

Breaking most records, in the negative sense

Italy's economy contracted (-0.6% q-o-q) for the seventh quarter in a row in 13Q1. As a result, the 1992 recession (lasting for six quarters) is not the longest on record any-more. What's more, be-tween 08Q1 and 13Q1, Italy's output dropped by a staggering 8.7%, which makes it the second worst economic performance in the industrialised world (after Greece). Consider that the country had the weakest growth during 2000-08 (7.8%) compared to its peers (see graph). Due to the negative carry-over effect from last year, Italy's GDP will fall by 1.6% in 2013 if output stagnates for the rest of the year. This means the government's -1.3% forecast is likely to be revised downwards, especially given the bleak outlook.

Change in GDP (2000-2008)

Source: Reuters EcoWin

Expenditure breakdown paints a downbeat picture

The expenditure breakdown of GDP shows that, similar to the previous quarter, household consumption and fixed investment contributed negatively to the headline growth figure. At least, the former declined at a smaller rate compared to 12Q4. Government consumption was flat once again. Net exports managed to knock 0.1%-point off growth. To be sure, this cannot be entirely blamed on the appreciation of the euro (2.6% on a trade-weighted basis) between 12Q4 and 13Q1. Since weaker inventory formation acted as the largest drag on growth in 12Q4, it was not surprising to see it contribute positively in the 13Q1. All in all, the breakdown shows that the major growth drivers are still very weak. 

Contribution to quarterly growth

Source: Reuters, EcoWin

Hard data point to better economic conditions…

Although we expect GDP to fall in Q2 as well, the pace of decline should be more moderate. This is supported by hard data. For one, the rate of de-cline of industrial produc-tion (IP) in April (-0.3% m-o-m) was smaller compared to the pre-ceding two months (which both saw a monthly decline of 0.9%). We should note that IP will contract in Q2 unless it grows by 1.2%, on average, in both May and June. Meanwhile, manufacturing orders have increased in March (1.8%) and April (0.6%) after declining in the preceding four months. The trade balance increased from EUR 2.2bn in Q1 to EUR 2.7bn in April. Finally, retail sales (values) dropped by only 0.1% in April after falling by 0.9% in Q1.

Industrial production and GDP

Source: Reuters EcoWin

…but more timely indicators give mixed signals…

The more timelier business and consumer sentiment data provide a mixed picture of the economy. While the European Commission (EC) Economic Sentiment Indicator increased to 86.6 in June from 84.0 in May, the ISTAT Economic Sentiment Indicator decreased to 76.1 in June from 80.2 in May. The manufacturing PMI rose from 47.3 to 49.1 in June. The June services PMI was not released at the time of writing but it did drop by 0.5 points between April and May. Consumer confidence has increased between May and June based on both ISTAT's survey (from 86.4 to 95.7) and EC's survey (from -32.2 to -19.2). Overall, we need more observations to better gauge the pace of activity going forward.

EC Economi Sentiment Indicator, ISTAT business confidence index, PMI manufacturing and PMI services

Source: Reuters EcoWin

…and further rise in bond yields can be worrying

A major risk to Italy's outlook is the recent bond market sell-off following the 'taper talk' in the US. Government bond yields (10yr) rose by 63bps between May 22 (Bernanke's testimony) and June 28. Last week, the Italian debt agency sold EUR 5bn of bonds at the highest yields in three months. Note that the yield spread versus German bunds has not increased much. This means interest rates are not rising due to increas-ing fiscal risks in Italy. On a positive note, we saw some retracement of yields following ECB president's statement that an exit from the accommodative stance is "still distant". Should the market lull prove temporary, fiscal risks will rise and the recovery will be further delayed.

Italian government bond yield and spread versus German government bond yield (10y)

Source: Reuters EcoWin

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