Thursday, May 22, 2008

Italy Consumer Confidence

Italian consumer confidence bounced back somewhat in May, rising to its highest level so far this year. The announcement was made the day after Prime Minister Silvio Berlusconi formed a new government and announced tax cuts and relief for homeowners facing higher mortgage payments.

The Rome-based Isae Institute's consumer confidence index, calculated from a survey of 2,000 families, rose to 103.2 from a revised 99.9 in April. The increase was the second monthly gain since the index fell to a four-year low in March, but the reading is still well down even on the level being registered in the second half of last year.





Consumer optimism about their short-term prospects surged to 101.7 from 95.6, while confidence about the economic situation rose to 84.9 from 79.6, Isae said today in its report. The change of governement and the fiscal promises seem to be providing some sort of ashort-term boost, but the scenario in the medium run still remains pretty bleak.

The first legislative act of the new government yesterday was to scrap the country's main residential property tax and reduce levies that workers are charged on overtime pay. The government also announced an agreement with banks to allow homeowners to freeze mortgage payments at 2006 rates, a measure that could affect 1.25 million families. More than 70 percent of Italians back the measures, a survey by polling company IPR Marketing showed today.

Eighty-seven percent of Italians support the removal of ICI, a tax property tax homeowners pay to local authorities, IPR said. The pollster surveyed 1,000 Italians yesterday, after Berlusconi held his first policy making cabinet meeting and confirmed the abolition of the tax. No margin of error was given.

Confindustria President Emma Marcegaglia also expressed support for the government's initial measures during a speech in Rome thi morning. Referring to the tax cut, Marcegaglia said she was ``satisfied with this first step'' and emphasised that Confindustria would "collaborate'' with the government on measures to improve the country's competitiveness.

The agreement between the government and the Italian banking Association on mortgages will allow homeowners with variable-rate loans to lock in monthly payments at levels they were paying before interest rates began rising. The European Central Bank has doubled its benchmark rate to 4 percent since Dec. 2006, pushing up the cost to homeowners with variable-rate mortgages.

Italians who take advantage of the new measure will make payments at the 2006 levels for the duration of the loan. At maturity, if rates have risen or held at the post-2006 levels, the loan will be extended to allow banks to recover what they would have earned without renegotiation.

The big question, however, is not so much the cuts themselves, as how they are to be paid for. With the credit ratings agencies and the EU Commission now breathing down there necks the Italian government have, at this point, very little margin of manouevre, and cuts here must be counterbalanced by increases there or spending cuts elsewhere, and especially as income will slow as a result of the stagnant economy.

The tax cuts will be worth about 4 billion euros ($6.3 billion), Finance Minister Giulio Tremonti said yesterday. Tremonti also said the cuts will be fully financed and won't increase Europe's largest debt. The government will cut public spending to pay for the tax cuts, Tremonti said. He added that the government has already identified 2.6 billion euros in spending cuts to help finance the tax package. Further measures would be adopted in June to produce more financing to cover the lost revenue.

Looking out into the medium term though, Finance minister Giulio Tremonti said that Italy's economy will most probably stall this year and that there are no "easy fixes". With the continuing rise in energy and food prices Italians remain on tight budgets and according to the purchasing managers index Italian retail sales have been falling for the past 14 months.

The present government's outlook is even gloomier than the European Commission's forecast of 0.5 percent growth, which may make Italy the slowest-growing economy in the euro region in 2008 (we still have to see how rapidly the Spanish economy actually slows this year). The Italian economy may well have already slipped into recession either in the first quarter of this year or in the last quarter of 2007, and has suffered three recessions between 2001 and 2005. In any event we should not be living in the expectation of any rapid "bounce-back" here.

However the long wait on the GDP data front should come to an end tomorrow, since the national statistics office, Istat, will release growth figures for the fourth quarter and first quarter of 2008 at 11 a.m. Rome time.

Posted by Edward Hugh at 10:51 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.