RaboResearch - Economic Research

Italy: The road to Rome is still very long

Economic Update


The Italian economy stayed in recession in 13Q2. Sentiment is improving, but domestic demand will be too weak to support growth in the coming quarters. Meanwhile, political turmoil is making markets nervous, which further hampers the recovery.

Recession becomes less severe, but continues

In 13Q2, the economy contracted for the eighth consecutive quarter (-0.3% q-o-q). Since its pre-crisis peak, the longest recession in Italy’s history has led to a 8.9% drop in output. At least, the economic contraction in 13Q2 was substantially less than in the previous two quarters. The expenditure breakdown shows that this was mostly owing to the positive contribution made by net exports. The fact that fixed investment acted as a smaller drag on growth helped as well. The decline in private consumption was only slightly smaller than in 13Q1 and government consumption again stagnated amid a tight fiscal policy. Inventory formation was the largest drag on growth.

Going forward, sentiment indicators point toward a minor fall in GDP in 13Q3. Both the manufacturing PMI and the Economic Sentiment Indicator (ESI) rose sharply over the past few months. In August, the former rose for the fifth consecutive month and even entered the expansionary territory (51.3), which bodes well for industrial production in the coming months. Meanwhile, the ESI in August reached its highest level since end-2011. The improvement in sentiment was broad based with only producers in the construction sector being slightly more pessimistic. As regards consumer confidence, the drop in the ‘major purchases’ sub-index indicates that households are still hesitant about loosening their purse strings. All in all, sentiment is improving but it still remains at depressed levels, which means we should not get overly excited. 

Figure 1. Recession continues
Figure 1. Recession continuesSource: Reuters EcoWin
Figure 2. Sentiment on its way back up
Figure 2. Sentiment on its way back upSource: Reuters EcoWin

Domestic demand is not recovering yet

Domestic demand is expected to remain very weak in the coming quarters. Job uncertainty continues to hamper consumers to spend more. In July, the unemployment rate stood at 12.0%; slightly below its all-time high of 12.2% in May. The minor fall in the unemployment rate was due to a decrease in the labour force and not a result of higher employment growth. Given the expected continuation of Italy’s recession, we do not see a considerable improvement in the labour market in the coming months.

As an aside, given the headwinds faced by households, there is now more opposition against the planned VAT hike from 21% to 22% in October. In our view, another postponement (to January 2014) is likely. This helps keep inflation (1.2% in August) low, which should support households’ purchasing power. The VAT postponement may lead to a front-loading of consumption in 13Q4. This will probably be followed by a drop in consumption in the first quarter of 2014. Note that private consumption may have already enjoyed a robust growth in 13Q3 given households’ expectation of a VAT increase in October. 

Figure 3. Unemployment expected to remain high
Figure 3. Unemployment expected to remain highSource: Reuters EcoWin
Figure 4. Low inflation is welcome
Figure 4. Low inflation is welcomeSource: Reuters EcoWin

Businesses are facing strong headwinds too, which suggests that they are in no hurry to expand their production capacity. The domestic economic outlook remains very weak, credit conditions are very tight, and there is ample slack in the economy. Having said that, the remarkable increase in the capacity utilisation rate in 13Q3 bodes well for investment growth in 2014. We are not sure, however, if this pace of improvement will continue going forward.  

Political uncertainty is a dark cloud hanging over Italy

News from the political front is weighing on investor sentiment. The recent political turmoil has led to rising government bond yields. The possibility that the Senate will vote Berlusconi out of the Parliament, as a consequence of his tax fraud conviction, is leading to fears of a coalition break-up. Berlusconi and his party (PDL) threaten to withdraw support for the government if the former prime minster will indeed be ousted from the Parliament, but the centre-left party (PD) is unlikely to yield. According to current polls, the PDL is unlikely to benefit from pulling the plug as it would be very difficult to win a clear majority in new elections. Therefore, it is more likely the PDL will try to use the current debate over next year’s budget law, by advocating tax cuts for example, to climb in the polls before calling for new elections. That said, it is very difficult to predict what Berlusconi will actually do. The increased uncertainty about Italy’s political stability may continue to push up bond yields and thereby lead to a deterioration of government finances.

Figure 5. Bond yields react on politics and policy
Figure 5. Bond yields react on politics and policySource: Reuters EcoWin
Table 1: Forecast
Table 1. Source: Reuters EcoWin, Rabobank

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