Friday, February 22, 2008

February EU Commission Interim Forecast

The European Commission released a new interim forecast for the EU economies yesterday. Of particular note was the fact that the forecast significantly reduces the growth forecasts at the same time as sharply raising its inflation estimate The Commission said it was concerned that expectations of steadily rising prices were becoming entrenched in the 15-nation area.

My own opinion is that the current forecasts are far more realistic than than those issued in last November's autumn review. The outlook for growth in the eurozone as a whole for 2008 has been cut to 1.8 per cent from an earlier 2.2 per cent, but of more significance perhaps are the individual country estimates. Italy, which has been the eurozone’s slowest growing economy for the past 15 years, once again comes in at the bottom of the pile, with the Commission halving its growth forecast for this year to a mere 0.7 per cent. This follows a downward revision of the Italy growth forecast by the Bank of Italy (in the middle of January) to 1%, and a revision (earlier this month) by Confindustria, Italy's largest employers' lobby, who slashed their forecast also to 0.7%. Back at the start of January I said the following on this blog:


I personally will be very surprised if we still see calendar year 2008 anything like as high as 1.8%, but more to the point even 1.3% may be rather on the high side if we get a significant deterioration in the external environment, especially in Eastern Europe on which Italy is fairly dependent, and where the Italian banking sector has significant exposure. So that puts me much nearer to Pillona's "basement bargain" number of 0.5% than to any of the others. One of the reasons for my pessimism relates to my assessment of Italy's current trend growth rate, and to the level of fiscal and monetary tightening which may be operating on the economy even as it slows.


I wouldn't say it exactly makes me happy to be being proved right here, but we do need some more realistic perspective on Italy's current growth potential from those responsible for forecasts and policy, and some more realistic appraisal of the problems Italy faces (ie of population ageing) to try and understand why things are this way, rather than assuming it is all to do with some sort of congenital weakness on the part of the Italians themselves.

The Commission lowered its country forecasts for Germany (to 1.6 per cent, from 2.1 per cent), and France (to 1.7 per cent, from 2.0 per cent), for the UK (to 1.7 per cent, from 2.2 per cent), and for Spain (to 2.7 per cent, from 3.0 per cent). Of these the French one looks to be the most realistic. The German forecast obviously contains strong downside risk, while the Spanish one seems to be talking about "another country" from the one I live in, when we come to look at the rate of the slowdown in the real economy (retail sales, industrial output, services etc), and add to this the growing tensions in the banking and financial sectors. I would stick my neck out and go for sub 1% growth in Spain this year, and feel reasonably comfortable with this.

Economy and Finance Commissioner Joaquim Almunia stressed the Commission’s view, which has been expressed many times since the financial market turbulence began last August, that the European economy would weather the storm because of its "sound fundamentals" – stable public finances, no huge current account deficits, relatively low unemployment and stronger international competitiveness. The strange thing is that he actually comes from Spain, a country which, it is true, has sound public finances at this point, but does have a huge (or whopping) current account deficit, which since last autumn it is having trouble financing since the monthly inflow of funds has dropped by around half, high (and growing) unemployment (around 10%) and poor producyivity growth (one of the worst in the EU) and hence comparatively weak international competitiveness. For these and many other reasons I suggest the 2.7% number is absolutely "pie in the sky", and may have a lot more to do with the fact that Spain is going to have elections in the middle of next month, with Mr Almunia's own party (PSOE) attempting to secure re-election.

On the inflation side the Commission raised its estimate for 2008 for the 27-nation EU to 2.9 per cent from the earlier 2.4 per cent, a revision which won't make the task of the ECB any easier when it comes to trying to use monetary policy to address the growth slowdown issues.
Posted by Edward Hugh at 8:48 AM

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Italy At A Glance - January 2008

Welcome to the Italian Economy Watch Blog. Below you will find the normal chronological blog posts. But first we would like to present some charts which provide background data which we hope will help the first time reader better assess and get to grips with the argument being presented on the blog. In what follows you can find charts for Italian male life expectancy, median age, quarterly GDP growth, inflation, household demand, retail sales, and import and exports growth. Basically this data provides a summary of the argument which we are presenting on this blog, which is that in order to understand Italy's long term and ongoing economic malaise you need to understand something about Italian demography, and it's macroeconomic consequences. Please click on thumbnails for better viewing.

On the left you can see a chart for Italian male life expectancy, and on the right there is one showing the evolution of the Italy's median age between 1990 and 2020. Just why such factors are important, and need to be taken into account along with more standard macro economic data in accounting for Italy's stubbornly low growth rate since the mid 1990s is explained in the posts.

With such weak internal consumption growth Italy badly needs to run a trade surplus to obtain the economic growth necessary to make public finances sustainable. In this Italy is similar to Germany and Japan, and different from domestic consumer driven economies like the UK, France and Ireland. Long term fertility and life expectancy really do matter, since they condition labour force growth



and consumption patterns, and with these productivity and the growth of internal credit and consumer demand. Above left you can find Italy's ferility rate, and above right the evolution of the 25 to 49 age group, which has just passed it historic peak. On either side here you can see charts for recent quarterly GDPand long run annual GDP.


Next on the left we have a chart for recent movements in Italian inflation while on the right we can see changes in the trade gap between exports and imports. Inflation is reasonably tamed in Italy (now why?), despite the recent slight uptick, but it is Italy's inability to generate a trade surplus which is the main problem structurally.


Now on the left we have the chart for household consumption and on the right the recent retail sales data. Finally the chart on the bottom left shows recent movements in Italy's business confidence index,while the chart on the right shows the equivalent data for consumer confidence.Bottom line, the evidence of growing weakness is everywhere.

Arguably these are all the data points you need to understand my lengthy post on The Euro Area and Italy's De-Facto Dependence On Exports, as well as why it is that the danger Italy may once more fall into recession presents us with the difficulty of what the credit ratings agencies will say about the resulting impact on the government debt situation.


2008 Forecasts: The OECD in December revised their 2007 Italian forecast down to 1.8%, and the 2008 one down to 1.3%. Confindustria also revised their forecast down in December, arguing that growth would slow to 1 percent in 2008 from an 1.8 percent this year, citing factors like the rising cost of food and oil and the rise of the euro against the dollar. Such numbers are clearly not encouraging, but arguably downside risk for 2008 is greater even than either the OECD or the Confindustria forecasts reflect Morgan Stanley's Vladimir Pillona is somewhat more sanguine. While presenting the MS central forceast for Italian economic growth to slow to 1.0%Y in 2008, from 1.8%Y in 2007, he goes on to note that "even annual GDP growth of 0.5%Y next year has a significant possibility of occurring, as shown by our model’s forecast error bands".

I personally will be very surprised if we still see calendar year 2008 anything like as high as 1.8%, but more to the point even 1.3% may be rather on the high side if we get a significant deterioration in the external environment, especially in Eastern Europe on which Italy is fairly dependent, and where the Italian banking sector has significant exposure. So that puts me much nearer to Pillona's "basement bargain" number of 0.5% than to any of the others. One of the reasons for my pessimism relates to my assessment of Italy's current trend growth rate, and to the level of fiscal and monetary tightening which may be operating on the economy even as it slows. During 2007 the Italian govenment has been running a fiscal deficit of comfortably below the 3% of GDP required by the EU commission. But since this fortunate situation was in part acheieved by the use of one off measures, and in part by the strong tax inflow from the above trend growth, the government will need to maintain a comparatively tight fiscal stance to keep things on course, and any attempt to further loosen may run into real problems with the EU commission and the credit rating agencies. And as I keep arguing, it is very hard to see an accomodative monetary posture from the ECB in the near future. The IMF in their October World Economic Outlook came in with a similar figure of 1.3% for 2008, the Economist Intelligence Unit is forecasting 1.7% in 2007 and 1.4 in 2008, and the latter 2008 figure was also endorsed by the EU commission in its November forecast.

As I indicate, my own view is well to the downside of all this. The only apparent bright spot on the horizon is employment, but I am dubious that in the context of Italy's ageing workforce this will work through as some are hoping, as I expain at some considerable length in this post here. My opinion is that Italy will enter recession at some point during 2008, and that we may well have 2 consecutive quarters of negative growth. The continuing high euro will maintain pressure on Italian exports, and high oil and food prices will maintain pressure on the inflation front, at least in the firts half of 2008. At the same time, and despite rumours that Romano Prodi's government is compemplating a large tax cutting package, I anticipate that the fiscal environment will remain tight. Italy's large (106% GDP) accumulated debt, and the vigilance from the gentlmen at Standard and Poor's and the other credit rating agencies more or less guarantee that.

As most of the forecasts suggest, we have been seeing growth which is somewhat above trend during the upswing in the last couple of years, so it would not be surprising if we now saw some below trend growth. Trend growth (over a 5 year average) in Italy may even have fallen into the 0.5 to 1% range, so if I have to put a number I would say 0.7% with a definite "downside risk" tag attached. The nearest forecast to this that I have seen is the 1% one from the Morgan Stanley GEF team. The implications of such sustained low growth are, I think, important, since if Italy cannot find the way to raise trend growth up towards the 2% mark there is simply no way the government debt can be stabilised and sustained. And with each passing year we have one year less to crunch time.