RaboResearch - Economic Research

Italy: a setback, but no game changer

Economic Update

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In 14Q1, GDP volume fell again after only one quarter of growth in more than two years. Private consumption, however, did increase for the first time since 2010. Underlying data suggest the economy will muddle through during the rest of the year.

Back into the red figures

In the first quarter of 2014, GDP volume contracted by 0.1% q-o-q, after a first minor uptick in more than two years in the final quarter of 2013. Inventory formation again had a negative contribution (-0.2%-point). Fixed investment volume also subtracted 0.2%-point from the headline figure. The contraction was mostly due to a fall in investment in transport equipment, after a surprisingly strong performance in the previous quarter. Net trade had the largest positive contribution (0.2%-points) as export volume grew faster than import volume. Most noteworthy, though, private consumption supported growth for the first time in three years (0.1%-point).

Figure 1: GDP volume contracted
Figure 1: GDP volume contractedSource: Reuters EcoWin
Figure 2: Sentiment still improving
Figure 2: Sentiment still improvingSource: Reuters EcoWin

Sentiment improves, but not in all sectors

Looking forward, sentiment indicators signal GDP volume will not contract another year in 2014, despite their minor worsening in June. The economic sentiment indicator (ESI) of the European Commission stood above its long-term average for the fourth consecutive month in June, albeit only slightly (100.3, long-term average is 100). In May, consumer confidence reached its highest point in more than 10 years and producers in the retail sector are very positive as they expect their business environment to improve substantially. Also, the purchasing managers index (PMI) in the manufacturing sector still stands above its growth-neutral level of 50 in June (52.6), though at a 3-month low. Sentiment in the construction and services sector remains very downbeat. Despite overall mildly positive sentiment, we expect the economy to muddle through in the coming quarters as domestic demand still faces headwinds.

Government’s hands are tied

The government, for example, will need to pursue a tight fiscal budget in order to comply with Europe’s budget rules and to bring down its enormous debt ratio. More austerity measures than currently announced are likely to be implemented this year as Italy is still at risk of non-compliance with the Stability and Growth Pact, according to the European Commission (June). Even though the fiscal effort will be much lower than in 2012, it cannot deviate considerably from that in 2013 with negative effects on GDP volume growth.

Consumer sentiment outpaces hard data

At the same time, we do not expect strong private consumption growth going forward as real household disposable income is still low and under pressure (around 13% below its pre-crisis peak, a 26-year low) for several reasons. First, hourly wage growth (1.15% y-o-y in April) has never been weaker and with a very high unemployment rate (12.6% in May, figure 3) wages are unlikely to start growing fast in the near term. We believe it will take time before job creation takes off to bring down unemployment, which is confirmed by producers’ employment expectations. Second, the tax burden will not be reduced much any time soon as the government has to obey the European budget rules. A little bit of respite for households comes from the ultra-low inflation level (0.4% in May). Strong confidence in the new PM Matteo Renzi in combination with good economic news from abroad, are likely to be the drivers behind the currently historically high consumer confidence and low unemployment expectations. But it is insufficient to increase the still exceptionally low expressed and expected willingness of consumers to spend money.

Figure 3: Labour market still weak
Figure 3: Labour market still weakSource: Reuters EcoWin
Figure 4: New orders bode well for investment
Figure 4: New orders bode well for investmentSource: Reuters EcoWin

Ups and downs in the investment cycle

Investment volume is likely the only component of domestic demand that will grow this year, albeit fairly slowly. This view is supported by the improving order position in the manufacturing sector (figure 4). But, amongst other things, the still low capacity utilisation rate in the manufacturing sector and weak domestic economic outlook remain to act as a drag on investment growth. Moreover, banks are still tightening credit standards for loans to non-financial corporations (figure 5), though at a slower pace than before. Demand for loans remains very weak, but did not contract in the first quarter of this year for the first time since end 2011 (figure 5). To sum up, the outlook starts to brighten, but the sky is not clear yet.

Figure 5: Credit standards tightened again
Figure 5: Credit standards tightened againSource: Bank of Italy
Table 1: Forecast table Italy
Table 1: Forecast table ItalySource: Reuters EcoWin, Rabobank
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