RaboResearch - Economic Research

Italy: once in recession, always in recession?

Economic Update

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  • In 14Q3, GDP volume contracted by 0.1% q-o-q. Investment acted as the largest drag.
  • In 2015, GDP volume is expected to grow slowly after three years of contraction, mostly on the back of foreign demand as domestic demand continues to face severe headwinds.
  • Unemployment has hit a record high and employment growth will be slow going forward. The recently approved labour market reform bill is unlikely to fasten job creation in the short term.

Investment largest drag on growth in 14Q3

In the third quarter, GDP volume shrank again (-0.1% q-o-q). Out of the last thirteen quarters, GDP volume contracted eleven times and stagnated twice. In fact, when including this year’s expected contraction (about 0.3%), the Italian economy will have contracted five out of seven years since 2008. GDP volume has fallen by 9.5% since the pre-crisis peak and industrial production even by 25%.

In 14Q3, investment acted as the largest drag on growth (figure 1) and subtracted 0.2%-point from the headline growth figure due to a quarterly contraction of 1%. But also inventory formation and government consumption contributed negatively (both -0.1%-point). Private consumption and net exports lifted growth again (both +0.1%-point). Private consumption grew marginally (0.1% q-o-q), in line with the past four quarters. Net international trade growth was positive owing to an increase in exports (0.2% q-o-q) and a fall in imports (-0.3% q-o-q).

Final quarter 2014 likely to be weak

Looking forward, sentiment indicators show a weak start of the final quarter of 2014. In fact they signal a deterioration of the economic landscape in 14Q4 compared to 14Q3. The Economic Sentiment Indicator (ESI) dropped below its long-term average (100.7) already in August and reached a year-low in November (95.9). In addition, the Purchasing Managers ‘Index (PMI) in the manufacturing sector fell slightly below the growth neutral value (50) in October and remained flat in November (49.0). This signals the manufacturing sector contracted in the first two months of 14Q4 compared to the preceding months.

Figure 1: GDP volume contracted with 0.1% q-o-q
Figure 1: GDP volume contracted with 0.1% q-o-qSource: Macrobond
Figure 2: Sentiment indicators suggest a weak 14Q4
Figure 2: Sentiment indicators suggest a weak 14Q4Source: Macrobond

Slow GDP volume growth in 2015

In 2015, GDP volume is expected to grow slowly after three years of contraction, mostly on the back of foreign demand as domestic demand continues to face severe headwinds. Foreign demand is supported by an improving economic climate in Italy’s main trading partners and the weaker euro. However, we should bear in mind that demand dynamics continue to be weak in the eurozone and that Italy’s relative (price) competitiveness has worsened over the past years, especially compared to eurozone peers. At the same time, domestic demand is held back by an uncertain and weak economic outlook, still low capacity utilisation rate (figure 3), tight credit standards and high unemployment (figure 4). If implemented, the proposed income and business tax cuts in the budget 2015 could support domestic demand. But, given Italy’s weak public finances and Europe’s budget rules, it is uncertain if these tax cuts can be fully implemented without introducing possibly equally growth damaging measures to raise revenue or cut spending. In the end, the government is unable to greatly support growth.

Figure 3: Capacity utlisation rate below historic average
Figure 3: Capacity utlisation rate below historic averageSource: Macrobond
Figure 4: Unemployment at new record-high
Figure 4: Unemployment at new record-highSource: Macrobond

Weak labour market but rising real wages

Consumers are not expected to notably raise spending in the coming quarters. In fact, private consumption growth is expected to remain near zero in 2015 (table 1). Private consumption is held back by high unemployment and low wage growth, but supported by low inflation (figure 5) and possibly the tax cuts announced for 2015. In October, the unemployment rate rose to a new record high of 13.2% (12.9% in September) on the back of a growing labour force and decreasing employment (figure 4). The weak economic outlook and expressed employment expectations and hiring intentions of producers, suggest employment growth will be very subdued at best in the coming quarters. The recently approved ‘Job act’ (labour market reform bill) is unlikely to induce faster job creation in the near term, even though the bill is meaningful by historical standards. The bill only presents guidelines and it will take a few months to draft the implementing acts and make them go into effect. Furthermore, the bill is not quite a game-changer in terms of labour-market flexibility and usually it takes a couple of years before labour market reforms have an effect on employment and output.

Figure 5: Historically low wage growth outpaces inflation
Figure 5: Historically low wage growth outpaces inflationSource: Macrobond

The budget 2015: fiscally neutral or tightening?

In March, the European Commission (EC) will examine whether Italy respects the European budget rules, based on the finalization of the budget laws for 2015. Currently, Italy’s budget draft 2015 does not include sufficient structural budget cuts (0.1% of GDP). If Italy will not have presented a sufficiently detailed structural reform plan by March, the EC might request an improvement of the structural budget balance in 2015 of 2.5% of GDP. A fiscal effort this large would likely deteriorate domestic demand significantly. Besides, it would imply a larger effort than required under Italy’s excessive deficit procedure that closed in 2012.

Table 1: Forecast table Italy
Table 1: Forecast table ItalySource: Macrobond, Rabobank
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