RaboResearch - Economic Research

Italy: Economic outlook is improving as the economy is opening up

Economic Update

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  • Italy started the year on a weak footing, but the outlook has been brightening over the past weeks
  • Infection rates have consistently fallen since end-March and vaccination rates rising
  • The economy is opening up and activity has rapidly been gaining speed
  • We forecast Italy’s GDP to grow with 4.8% this year and 3.5% next year
  • This would bring the economy back at its pre-COVID level in 2023Q1
  • We expect consumption to get a boost from a fall in restrictions-induced forced savings, lower precautionary savings and pent-up demand out of both income and savings
  • Yet precautionary savings will remain larger than pre-crisis for quite some time, while pent-up demand in services and spending of excess savings have their limitations
  • Demand for labor will improve in the coming months, but it will take quite some time still for the labour market and households’ disposable income to fully recover

Light at the end of the tunnel

Italy started the year on a weak footing, but the outlook has been brightening over the past weeks. Infection rates have consistently fallen since end-March, thanks to a combination of strict containment measures and rising vaccination rates – over 36% of the population has had at least one shot and 18% is fully inoculated. The improvement in the health situation has pulled all Italian regions into the yellow category of Italy’s traffic light system over the past weeks, and three small regions have even been upgraded to so-called ‘white zones’. Accordingly, non-essential retail stores across the country have reopened and restaurants can again serve customers at their terraces, amongst other things. And tourists are welcome again. These developments have spurred retail and recreation activity since mid-April (figure 1), albeit from a very low base. In addition, the improving global environment has supported the manufacturing sector (figure 2).

Against this backdrop, combined with the expected further reopening of the economy over the coming weeks, we foresee growth strengthening in Q2 to around 1% q/q and a pronounced recovery in the second half of the year. Thereafter, the recovery will advance at a more muted pace. We forecast GDP to grow with 4.8% this year and 3.5% in 2022[1]. This would bring Italy’s GDP to 2.6% below its pre-COVID level by the end of this year and back to its pre-COVID level in 2023Q1– one year later than the Eurozone. Italy’s outlook is supported by the EU recovery fund, Draghi, and the importance of manufacturing, but hampered by worsened balance sheets of low-income households and firms in hard-hit sectors, and the importance of tourism (12% of GDP). The latter will be hindered by (international) restrictions for longer and tourism benefits less from pent-up demand than other sectors. It is unlikely people will catch up all missed trips and holidays at once when allowed. It has also larger losses to overcome, hurting investment and employment growth.

Figure 1: Reopening of economy spurs activity
Figure 1:  Reopening of economy spurs activitySource: Macrobond, RaboResearch
Figure 2: Manufacturing leading the way, but services have also turned a corner
Figure 2:  Manufacturing leading the way, but services have also turned a cornerSource: Macrobond, RaboResearch

Footnote
[1] Please note that these figures have been updated after revision of Q1’s GDP figure from -0.4% q/q to +0.1%q/q.

What to expect from consumption

An important determinant for growth going forward is the size of the consumption boost as the economy is reopening and the outlook improving. The boost will mainly come from a fall in restrictions-induced forced savings, but also from lower precautionary savings and pent-up demand out of both income and savings. Yet an instant return to pre-crisis levels should not be expected, let alone an overshoot.

First, it will take some time for all (international) restrictions hampering activity in the important tourism sector to be lifted and there are some limitations to pent-up demand in this sector, while demand for certain goods has already seen an overshoot over the past year. Second, we think that only a limited amount of the EUR 80bn (5% of GDP) in excess savings built up last year will be spend in the foreseeable future, while an increase in prices will dampen the sales volume boost stemming from increased demand and spending (see also the box ‘No over-eating, but still overheating?’ in a recent special on Eurozone pent-up demand by my colleague Elwin de Groot). 

Importantly, low income workers with a high propensity to consume have seen their financial situation deteriorate last year and have not been able to save, while the highest income group with a lower propensity to consume seems to have been best placed to accumulate savings (see figure 4). In fact, more than 60% of households struggle to make ends meet at the end of the month, up 10 percentage points compared to pre-pandemic, according to a recent survey of the Bank of Italy. On the bright side, consumer confidence has improved significantly recently. Depending on what survey you look at, in May it reached its highest stance since the start of the pandemic (Istat) or in the past two decades (European Commission). The improvement is broad-based among income groups. Still, while unemployment expectations have improved a lot too, they remain very negative. Accordingly, we expect precautionary savings to fall substantially going forward but to remain larger than pre-crisis for quite some time in Italy.

Figure 3: Household income dropped by 2.9%
Figure 3: Household income dropped by 2.9%Source: Macrobond, RaboResearch calculations
Figure 4: Savings fell among low-income households
Figure 4: Savings fell among low-income Households Source: Macrobond, European Commission, RaboResearch

Labor market on the mend, but full recovery likely to take time

Finally, significantly improved employment expectations (figure 5) and a surge in vacancies suggest the labor market is on the mend, supporting income growth going forward. At the same time, however, government (job) support measures are coming to an end. A ban on layoffs and Covid-related short-time work arrangements –currently covering some 5% of total contract hours– are set to expire end June. According to the Bank of Italy, some 500,000 people could lose their job if the ban on layoffs expires. The trade union UIL has said it could even concern as much as 2 million employees. What is certain is that with employment still some 3.5% lower in March than end 2019 (about 1mn people) and hours worked down 7.5% in 2020Q4 compared to 2019Q4, there is much recovery necessary to return to pre-Covid levels. All in all, we expect that demand for labor will improve in the coming months, but that it will take time for the labour market, including wage growth, and households’ disposable income to fully recover.

Figure 5: Employment expectations on the rise
Figure 5: Employment expectations on the riseSource: Macrobond, RaboResearch
Figure 6: Hours paid via short-time work scheme down from top but still significant
Figure 6: Hours paid via short-time work scheme down from top but still significantSource: Macrobond, INPS, RaboResearch calculations
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