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Economy in Brief

Italian GDP Finalizes on Weak Trends
by Robert Brusca  March 5, 2015

Italy continues to struggle. Its GDP fell in Q4 and is net lower year-over-year. GDP in Italy is falling as fast year-over-year in Q4 as it was in Q3. That is not progress. Public consumption rose at a 1.7% annual rate in Q4 2014 but domestic demand still fell at a 1.7% pace. Italian exports are getting some traction as they are up by 6.4% Q/Q annualized and by 3.8% over four quarters. But the trade account is adding to GDP substantially by restraining imports. Domestic demand is lower on the quarter as well as year-on-year constricting imports which are up at just a 1.2% annual rate in Q4 and by 2% over four quarters.

Italy is trailing Germany and Spain as you can see on the chart. Among the 11 earliest EMU members (excluding Luxembourg), Italy has the third lowest Q/Q growth rate and the worst year-over-year growth rate. Italy has had the worst year-over-year growth or been tied for it for three consecutive quarters.

The Markit PMI data show some stabilization for Italy's industry and services sector but on still weak conditions. Recent surveys of business and household confidence from ISAE have showed some improvement among businesses and a spike higher for consumers. But we should put all this in perspective.

The expectations for QE by the ECB are high and much higher than is sensible. QE is being launched on a local level by the local representative central bank. The program is being executed at an already low level of interest rates so low that little further reduction can be expected on account of QE. If the notion is that QE will help through the LSAP (large scale asset purchases) channel as the Federal Reserve in the U.S. likes to think, then the problem in Europe is that banks are already encumbered with balance sheet issues and even more so than in the U.S. and are being leaned upon to raise more capital. Europe's securities markets are stepchild to what the Fed has had to work with in the U.S. The central bank cannot have it both ways. It cannot expect banks and securities markets to step up to the plate and lend and at the same time bash them over the head to recapitalize.

It is unlikely that the sopping up of `high quality' assets through a program of QE will lead European investors to buy more risky assets to stimulate the economy. In fact, the QE operation may simply wind up absorbing assets being offloaded by foreign central banks disappointed by not just falling bond yields but by a depreciating currency value as well.

Italy's consumer confidence on the ISAE measure is as high as it's been since 2002. That is a mark of significant improvement. But we have to ask, "What is behind it?" And what we find is a lot of hope. Italy's economy has not improved by that much. But the reading for the expected overall situation has improved sharply as has the reading for expected unemployment which has dropped by nearly 20 points in one month. This is the second largest month-to-month drop in expected unemployment in the history of the report going back to June 1998. Why? Based upon what? What else? Hope.

At the same time Italian politics is turned upside-down. There are still splinter parties that want to leave the euro area. Italy has undergone a good deal of pain to reduce its competitiveness loss vis-a-vis Germany. Since joining the EMU, Italy's HICP is up 35.6% compared to Germany's HICP which is up by 26%. Italy still has lost competitiveness, but its gap with Germany has been reduced. Historically, Italy, like other Southern European countries, has been used to having more government support and has run a relatively high inflation economy with periodic currency devaluations to restore competitiveness. That process stopped when the EMU was formed, but Italy did not halt its reliance on fiscal excess and is now paying a price for it.

While the current focus has been on Greece, Italy, Spain, Portugal and France, all have their own problems in the EMU. Thanks to a past severe banking crisis so has Ireland. There can be no pretending. Each of these countries needs to convince investors that it is signed on to make the hard choices to stay in the EMU. If Greece falters and leaves the EMU, that fact will ratchet pressure up on the other countries on this list. It is important for each of them to have programs that are committed to solving their problems. For now Ireland is on board; Portugal is on board; and Spain is a success story. France has gotten a pass on its debt deviation from the required debt-to-GDP ratio allowing it time to get back on track. Will France use that time wisely or not? And Italy is struggling without a clear plan. Italian optimism seems borne of the belief that the ECB/Bank of Italy can lift the EMU up by its own boot straps using QE. I am concerned that Italy needs to have more doing and less hoping.

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