We still of course are without detailed information on Italy's fourth quarter GDP performance (that is we really don't know whether or not Italy has entereda recession) but we do know that those who may well have seen some summary of the details are busily revising down there 2008 growth forecasts. The latest to join this list is the Italian Government itself, who today cut their 2008 economic growth forecast by more than half.
The Italian economy, which is still Europe's fourth-biggest, will grow at a rate of only 0.6 percent this year Finance Ministry said today in a prepared statement. That's down from a forecast of 1.5 percent in December.
The makes the Italian government even more pessimistic about Italy's coming growth performance than the European Commission or Confindustria (Italy's largest employers' organisation, who last month cut their 2008 forecast to 0.7 percent, a prediction which was later matched by the European Commission.
After lagging the EU average for more than a decade, Italy looks like it may well have the slowest-growing economy in the region this year, although we need to see what the final numbers turn out to be in some other weakening economies like Ireland, Spain, Greece or Portugal before we rush to too many conclusions here.
Most importantly this weak growth is likely to put increasing pressure on Italy's budget deficit, which the Finance Ministry now predict will rise to 2.4 percent of GDP in 2008, more than the 2.2 percent originally predicted but still under the European Union ceiling of 3 percent, if the target is achieved. The shortfall narrowed last year to 1.9 percent of gross domestic product, the least since 2000, according to ISTAT on Feb. 29. That's about half the 2006 deficit of 3.4 percent.
As I already noted in a post last week, the heightened risk aversion which is likely to prevail in global credit markets during 2008 has already sent the yield differential on Italian government bonds soaring, and this situation can not only be repeated but indeed get worse. And then there are the ratings agencies to think about. The problem here is that if you cry wolf often enough one of these days you really are going to get caught short, and Italian finances are now running dangerously near to that limit were a small problem turns into a serious issue.
Adding to the problems this time round is the fact that growth is steadily grinding to a halt at a time when the inflation rate is at an 11-year high of 3.1 percent. This situation of effective "stagflation" makes it very hard for the ECB to bring any meaningful relief on the interst rate front (which would also serve to loosen the euro-dollar) without bringing its credibility into question.
And to top it all, of course, we have the collapse of Prime Minister Romano Prodi's government on Jan. 24 after only 20 months in power. The uncertainty which this produces also helps muddy the economic water even more than it would otherwise be. Both leading candidates in the election campaign, two- time premier Silvio Berlusconi and former Rome Mayor Walter Veltroni, are promising tax cuts to help revive growth, but it is hard to see where the money for any of these tax cuts can come from when the country is going to find it hard enough to keep the deficit itself from rising even with the status quo being preserved.
Germany At A Glance, January 2008
Welcome to the Euro Watch Blog. Below you will find the normal chronological blog posts. But first we would like to present a special feature on the German economy, together with some charts which provide background data and which we hope will help the first time reader better assess and get to grips with the argument being presented here. The big question which arose concerning the Germany economy in 2007 was whether or not the new found dynamism in German economic activity constituted some form of remaissance, and formed part of a global decoupling process whereby a sustainable recovery in domestic demand was taking place. Analysts on this blog never really accepted this view. The key question and central enigma associated with the German economy is really why domestic demand should have remained so congenitally weak over such a considerable period of time. Since this phenomenon is also to be observed in the the two other societes with very high (circa 43) population median ages - Italy and Japan - we postulate that demographics and population ageing processes offer some part of the explanation here. Basically what we can observe as societies move above the 40 median age mark are a number of stylised facts. Weakness in domestic private consumption would be one of these, absence of consumer credit driven property booms would be another, growing pressure on the national debt as the elderly dependence ratio steadily rises would be another, and growing dependence on export growth for sustaining GDP growth would be the central feature of the whole edifice. We hope you will find the background data presented here useful in assessing the argument which we are presenting on this blog, which is basically that a key component in the longer term growth stagnation from which Germany is suffering has its roots in the underlying demographics. Basically and in the long run (possibly with a 30 year lag) fertility does matter. Please click on thumbnails for better viewing.
As can be seen from the chart this crucial age group touched its highpoint in 1997/98. This could be thought of as the moment of maximum capacity for the German economy since it includes the crucial 25 to 40 household-former, first-time-homebuyer group. In terms of credit expansion, it is this group which drives a significant part of internal demand.
The age group also includes another important group, the 35 to 50 years one. This group drives an economy in productive terms, since these are the prime age workers. If you think of a society as a 100 metres sprint athlete, then there is an age when this athlete is at the maximum of his or her running potential, an age after which each time they can only run the 100 metres more slowly.
Well a society is the same in terms of its collective economic potential, without addressing underlying issues either through fertility or immigration, it can only move forward more and more slowly. Consumption becomes flat, and GDP growth - gioven the external dependence - fragile.
Private consumption has hovered pretty close to the 60% mark for many years now, while government consumption - after moving sharply upwards as a total share in the first half of the 1970s has subsequently remained pretty constant, moving around the 19% of GDP mark. The big difference has been in the importance of fixed capital formation (GFCF) which reached from 1975 to 2000hovered around the 22 - 24% of GDP mark.
Prior to 1975 GFCF was at a much higher level, while post 2000 it has dropped substantially And So what we can see is that the year between, say, 1975 and 2000, when GFCF remaind a more or less constant share of GDP, constituted - to use the language of neo-classical economics - the constant growth period of the German domestic economy.The years prior to 1975 were the convergence, or "catch-up" years
And especially the 1960s, after Germany finally broke out of the destruction and devastation of WWII - while the years after 2000 constitute what the neo-classicists would call the "balanced growth period", although as we can see, it isn't very balanced, and there certainly isn't a steady state.
2008 Forecasts: There is a consenus at the present time that the German economy is slowing. Where there is no real consensus is over the rate at which it is slowing and where and when it will settle. It is clear that GDP growth in 2007 will be below the heady 3.1% annual rate achieved in 2006. The OECD last December revised their 2007 German forecast down to 2.6%, and their 2008 one down to 1.8%. The IMF in their October World Economic Outlook forecast growth for 2007 at 2.4%, slowing to 2% in 2008. Morgan Stanley's Elga Bartsch, while optimistic that the German economy will whether the credit crunch better than most (and here she may well be right) is somewhat more sanguine, putting 2008 growth at 1.5%. In general though I rather doubt her overview that "Germany could well be on the way to becoming the new growth locomotive in Europe." and especially her suggestion that "the phase of underperformance in terms of GDP growth, which has plagued Europe’s largest economy for years, is clearly over." Unfortunately, what we are arguing on this blog is that Germany's GDP growth rates since the mid 1990s are not some special kind of "underperformance", but what can be expected from a society with a rapidly rising median age which is increasingly dependent on exports rather than domestic consumption for growth.
The EU commission in it's November 2007 forecast was also convinced that the German economy was now on a "solid growth path", forecasting 2.5% growth for 2007 and 2.1% for 2008. I personally will be very surprised if we see growth in the region of 2% for the German economy in 2008, and I even consider the 1.8% from the OECD and 1.5% from Morgan Stanley still on the high side given the extent of downside risk. Basically the reasonably favourable depreciation rules which currently apply to German investment have been changed as of 1 January 2008, and we might reasonably expect to see some sort of impact on investment comparable with the negative shock which hit private domestic consumption following the VAT rise on 1 Jan 2007. In addition all the indications suggest that German consumption will continue to be weak in 2008. So if consumer consumption is at best flat, governemnt consumption equally so, and investment and construction weakening, we are simply lefy with export growth, and here the outlook is definitely more negative in 2008 than it was in 2007. The Spanish economy (one important German customer) is visibly wilting by the day, as is the UK (another big customer), but it is to Eastern Europe we must look for the biggest impact on German exports of any correction in 2008. Just one data point should suffice, Germany exports roughly the same value of goods to the Czech Republic (and more to Poland) as it does to China. This means that Geramny is proportionately not that exposed to any slowdown in China, but hugely exposed to any sudden shift in growth and demand in the East of Europe.
So I would say, that on current data, 1% growth in Germany in 2008 look a reasonable estimate at this point, but that this needs to be taken to mean with considerable downside risk. Germany is now tremendously dependent on what happens elsewhere, and until what does actually happen elsewhere becomes clearer it is difficult to be more precise on Germany. The only apparent bright spot on the horizon is employment, but I am dubious that in the context of Germany'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 Germany 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 German exports, and high oil and food prices will maintain pressure on the inflation front, at least in the first half of 2008. The ECB will probably switch stance towards rate reductions at some point, but since, as Elga Bartsch among many others so eloquently argues German internal consumption and investment are not especially dependent on credit conditions, easing from the ECB may not have as much impact as one would hope for.
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