Italy’s economic engine stalled again in the second quarter of the year. The lackluster recovery that seemed to have taken hold after three years of recession has turned out to be a flash in the pan. Growth ground to a halt amid structural deficiencies that continue to constrain the country’s full economic potential.
Headwinds triggered by post-Brexit uncertainty added to Italy’s woes by constraining investors and weighing on consumer and business confidence. ISTAT (Italy’s national statistics office) revealed that the economy recorded flat growth in Q2. Although the breakdown of the GDP components has not been released yet, Dun & Bradstreet expects that depressed domestic demand was the main factor behind the country’s economic deadlock.
Indeed, high-frequency and leading indicators show that a structural reverse in the hitherto flat economic trend is yet to materialize. Industrial output (which tends to be well correlated to real GDP growth) fell by 0.2% quarter-over-quarter in June, weighed down by a 1.9% drop in consumer goods, while the unemployment rate rose to 11.6% in June, up from 11.5% the month before.
Markit’s data reveal that activity in the manufacturing sector grew at its slowest rate for a year in July: Manufacturing orders, output, and employment all lost momentum. Similarly, the retail PMI fell further below the 50 mark that separates growth from contraction; the steep decline in the PMI signals underlying weakness in consumer spending, according to Markit.
Against this backdrop, the headline inflation index also continues to hover around zero due to slow growth, weak demand, and benign commodity markets. D&B sees some risks of current low price pressures translating into lower inflation expectations and pay growth, with negative known effects on households’ purchasing power.
Consumer prices fell by 0.3% y/y in Q2, while core inflation stood at 0.5% y/y, lower than its Q1 average of 0.7% y/y. Inflation should remain subdued in 2016-17, hovering around 0.2%. However, inflation should rise gradually over the medium term as the economic recovery gathers speed and improving labor market conditions add upside pressure on nominal wages, and thus on price levels.
The Italian banking sector has been under significant pressure since Brexit. After the vote, the Italian bank index dropped by some 26%, and even though it eventually recovered part of the losses, it remains close to its 2012 record-lows. A high volume of bad debts (worth some €360 billion), high operating costs, and low profitability due to current record-low interest rates are the main factors undermining the sector and constraining its capacity to lend to the real economy.
The Italian government recently announced an assistance package (worth some €40 billion) to prop up the ailing and undercapitalized banks. Although, under the new EU rules, public support for the financial sector is only allowed in specific (and strictly limited) circumstances, the EU gave the government a green light in June to guarantee (if necessary) debt issued by Italian banks. As such, banks will continue to have access to cheap EU funding, thereby eliminating liquidity risks.
Against this backdrop, Italy’s Monte dei Paschi di Siena (MPS) emerged as the worst performer in the July EU-wide stress tests aimed at assessing the financial health of the EU banks. In order to address the capital deficiencies, the bank has announced a €5 billion capital increase and a new business plan by September. The stress test was performed by the European Banking Authority to assess how 51 of the EU’s biggest banks would cope with an EU economic performance far worse than that expected in the baseline scenario through 2018. Under the stress scenario, MPS’s common-equity Tier 1 ratio (the test’s measure of a bank’s financial health) dropped to minus 2%. The ratio should be above 6%-7% for a bank to be regarded as healthy.
Daniele Fraietta has been a D&B economist for more than two years. He currently covers some Western European countries, notably Italy, Greece, Spain, and Ireland. For D&B, Daniele has also developed the new econometric framework for commodity prices and exchange rates forecasting. He has an MSc in Economics from the University of Rome Tor Vergata, a Master in Business Administration from The Polytechnic University of Milan, and a Master in International Business from the Chapman College of Business.