RaboResearch - Economic Research

Italy: Recession, there we go again

Economic Update

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In 14Q2, GDP volume contracted, again. Deflation may support consumption going forward, but lower consumer confidence and high unemployment temper expectations. For fixed investment, headwinds outpace tailwinds, so a firm recovery is unlikely.  

Back in recession

GDP volume shrank by 0.2% q-o-q in 14Q2 after contracting by 0.1% q-o-q in 14Q1 (figure 1). Accordingly, Italy is back in recession.  As eleven out of the twelve latest quarters posted a fall in GDP volume, the size of the economy is more than 9% smaller than just prior to the crisis.  GDP volume is at about the same level as in the beginning of the year 2000. 

Investment and export disappoint

Net exports and fixed investment are the ones to blame for the second quarter’s contraction (figure 1). With export growth (0.1% q-o-q) fairly below import growth (1% q-o-q), net exports subtracted 0.2%-point from GDP growth. Fixed investment subtracted an unexpected 0.2%-point. Admittedly, investment demand was expected to face strong headwinds, but quarterly growth of -0.9% is disappointing. On the contrary, private consumption again contributed positively, albeit only marginally (0.1%-point). The largest positive contribution to the headline growth figure was made by inventory formation (0.2%-point), after two quarters of acting as a headwind. Looking forward, a real recovery is not expected to come quickly as sentiment seems to have peaked already in April and economic fundamentals are not improving that much either. 

Figure 1: Recession all over again
Figure 1: Recession all over againSource: Macrobond
Figure 2: Sentiment indicators foresee stagnation
Figure 2: Sentiment indicators foresee stagnation Source: Macrobond 

Sentiment has passed its peak

The purchasing manager’s index (PMI) in both the manufacturing and services sector dropped to 49.8 in August, below the growth neutral level of 50, from respectively 51.9 and 52.8 in July. It was the fourth decline in a row for the manufacturing PMI (figure 2). Furthermore, the drop in the economic sentiment indicator of the European Commission (ESI) in August, from 101.9 to 97.8, was notably larger than its rise in July (from 100.3 in June, figure 2). In the manufacturing sector confidence decreased mainly on the back of worsened expectations on future production, but also on that of order books and recent production trends, which suggests industrial production might contract for another quarter (currently more than 24% below its pre-crisis level).  All in all, sentiment indicators signal economic stagnation is set to be the next station.

Deflation versus a weak labour market

In August, prices declined compared to the same month a year earlier with 0.2%, mostly due to a fall in energy prices; but, core inflation has been trending downwards for some months now as well (figure 3). This is the second time of mild deflation since the start of the crisis (as well in July 2009, according to the HICP definition). We note that if it were not for the VAT hike in October last year, prices would have started falling already in June (figure 3). Lower prices might support private consumption going forward. Several factors prevent us from getting too optimistic, however. For one, the increased disposable income of low wage earners resulting from a low-income tax cut in May has failed to induce very strong consumption growth so far. Furthermore, consumer confidence decreased in July and August, and especially expressed willingness/ ability to spend money on big-ticket items remains extremely negative. Employment also slightly shrank in July, leading to an increase in the unemployment rate to again 12.6% (from 12.3% in June, figure 4). Looking forward, based on the uncertain and rather weak economic outlook, job creation will at best be slow. Employment expectations of producers are, overall, still downbeat, especially in the construction sector. The only exception are producers in retail trade. Taking everything into account, we believe private consumption will not be a large driver of GDP volume growth in the coming quarters.

Figure 3: Deflation it is
Figure 3: Deflation it isSource: Macrobond
Figure 4: Unemployment rate still near record-high
Figure 4: Unemployment rate still near record-high Source: Macrobond

Investment growth, the weakest link?

The still rather low capacity utilisation rate in the manufacturing sector (72.5 in 14Q3) and the weak domestic economic outlook will remain to act as a headwind for fixed investment. In addition, y-o-y growth in new orders in the manufacturing sector, a leading indicator for fixed investment growth, started falling in July (-1.4% y-o-y in September).  On the upside, credit standards by banks were loosened in 14Q2, mainly based on an improved perception of the economic situation. This might help fixed investment in the third quarter of this year (figure 5). That said, it will take time before the severe tightening during the crisis is compensated. As a result of the rather sharp contraction in investment volume during the first half of the year and the remaining headwinds, fixed investment is expected to contract in 2014. 

Figure 5: Credit standards loosened
Figure 5: Credit standards loosenedSource: Bank of Italy
Table 1: Forecast table Italy [1]
Table 1: Forecast table Italy Source: Macrobond, Rabobank

 [1] Owing to new calculation methods for nominal GDP, government debt as a percentage of GDP will be reduced with a few percentage points. This is not included in our forecast yet.

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