Wednesday, March 12, 2008

Italian Government Halves the 2008 Growth Forecast

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.

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