Tuesday, April 29, 2008

Eurozone Retail PMIs April 2008

The Bloomberg Eurozone Retail Purchasing Managers' Index, an indicator based on a mid-month survey of economic conditions in the euro area retail sector and providing data one month ahead of government issued figures, fell a record 6.4 points from 48.2in March to a survey low of 41.8 in April. This signals the steepest monthly decline in sales since data were first collected in January 2004.

Retailers blamed a combination of bad weather, the timing of Easter, poor consumer confidence, squeezed household budgets due to rising food and energy prices for the steep drop in sales at the start of the second quarter. In Italy, ongoing political uncertainty was an additional factor cited by retailers.

Italian retail sales showed the largest fall of the three countries, with retail spending dropping at the fastest rate in the survey's history by a wide margin (the index was down from 36.4 to 31.4). Italian sales have now fallen for fourteen straight months.

German sales fell sharply, with the rate of decline similar to the three-and-a-half year record seen at the turn of the year. The index dropped from 51.5 to 44.6, representing a marked turnaround from the growth seen in February and March.

French retail sales showed the weakest decline of the three countries; nevertheless sales fell at the fastest monthly rate since January 2006 (the index slumped from 53.3 to 46.2). The April fall contrasted with robust increases in sales over the first quarter.

Sales fell below their levels of a year ago at the greatest extent yet recorded by the survey: The year-on-year sales index plummeted to a new low of 35.7, from 49.3 in March.

Prices paid for goods by retailers continued to rise at an elevated pace in April. The prices index fell from 67.4 to 66.5, but remained well above the long-run average of 58.0. The overall easing in purchase price inflation reflected a slowdown in France, to a seven-month low. In Germany, the rate of inflation hit a four-month high and was the sharpest of the three countries, while purchase price inflation in Italy accelerated slightly to a level exceeded by the survey high recorded last October. By sector, food & drink retailers again registered the sharpest overall rise in prices.

Retailers reported a widespread inability to pass on rising costs due o price resistance among cautious customers. As a result, gross margins in he retail sector deteriorated at the fastest rate yet recorded by the survey (the margins index slipped from 41.9 to 39.0). Survey-record rates of decline were seen in both Italy and France, with Italian retailers reporting by far the sharper fall of the two. A considerably more modest rate of margin squeeze was registered among German retailers compared to their French and Italian counterparts, though the rate of decline nevertheless accelerated since March.

Retail targets were missed in April to an extent seen once before in the survey's history (in May 2004). In some cases, poor sales relative to targets reflected an underestimation of the impact of the early Easter, but in most instances were linked to adverse weather conditions and subdued consumer morale. The index of actual sales relative to planned sales fell sharply for the second month running, from 36.4 to 31.2. Targets were again missed in all three countries, led by Italy and then France, which both saw record shortfalls. By sector across all countries, targets were missed for all sales categories. Moreover, the shortfalls in clothing & footwear, household goods and pharmaceuticals were all the greatest indicated to date.

The combination of rising non-staff costs and weak sales caused employment in the Eurozone retail sector to fall marginally in April, following marginal gains in the first three months of the year (the index fell from 50.1 to 49.5). A slight rise in French retail employment was countered by a small decline in Germany and a larger fall in Italy, where the rate of job losses in the past two months has been higher than at any time since late 2004.

French House Prices

There was an interesting piece in the Financial Times this morning about how the French property market was basically different from the Spanish and the Irish ones, and that no major "correction" in prices was to be anticipated in France (as opposed to a slight reduction in prices). Basically I think it would be a mistake to talk and think in terms of a eurozone wide property market (Germany and Italy had no major property boom in recent years) and factors like demographics and the lending attitude of the banks (fixed rate vs variable mortgages, loan to value ratios etc) seem to have been just as important as the lending rate set by the ECB (which has, of course, been the same for everyone.

Lending for house purchases across the eurozone rose at an annual rate of just 6.1 per cent in March, down from 6.6 per cent in the previous month (and we don't know the month on month changes, which are the ones that really matter), the European Central Bank reported on Friday. That was the weakest since at least 2000, when monthly data were first compiled.

In the coming downturn the outlook for the eurozone economies in general could depend crucially on the resilience of France, the 15-country region’s second biggest economy, where prices house prices have been buoyant in recent years, but where the Irish and Spanish (or UK) "excesses" seem largely to have been avoided.

French house price inflation peaked in early 2005 at an annual rate of 16 per cent but has since steadily declined and prices may now be on the point of turning negative if they has not already done so.

Policymakers’ may be deeply worried about the outlook in Spain and Ireland or – beyond the eurozone – in the UK. However, the risk that a dramatic housing market correction will seriously dent French economic growth seems limited.

House prices in France could fall by 3 per cent this year, according to some analysts. Nevertheless, the economic impact of fluctuations in property prices could prove much less pronounced than elsewhere.

France’s home ownership rate is 60 per cent, low compared with its European Union neighbours. Around 90 per cent of mortgages are fixed-rate, one of the highest proportions in the EU, and those that are variable are capped. There is virtually no “equity withdrawal” – which allows consumers to spend from borrowing on the back of the rising value of their homes – since it is tightly restricted.

French economic growth this year will slow, but more because of the pressure facing its corporate sector, for instance from a strong euro, high oil prices and tighter credit conditions.

Still, a slowdown in the property sector would weaken one of the bulwarks of French growth over recent years. The construction sector accounted for 38 per cent of all jobs created in France in 2005-06 and accounted for over a third of France’s 2 per cent gross domestic product growth in 2006.

The monthly survey series by FNAIM, the French National Property Federation, is showing a steady decline in the annual growth rate of property prices, from 3.4 per cent in January to 2.5 per cent in March. But a fall of apartment prices of 1.7 per cent in January has set alarm bells ringing among some analysts.

Thursday, April 24, 2008

Italian Consumer Confidence April 2008

Italian consumer confidence rose slightly (but ever so slightly, see chart below) in April - holding near its lowest level in almost four years as an economic slowdown prompts households to cut back on spending. The Rome-based Isae Institute's index, based on a survey of 2,000 families, rose to 99.8 from a 99.0 last month. The March reading was the lowest since May 2004.

Rising food costs and oil prices near the $120 a barrel mark are stifling consumer spending as wage growth stagnates. Even with economic growth slowing, higher energy and commodity prices have pushed the inflation rate to its highest in at least 11 years, further sapping optimism.

The Italian economy may have already slipped into recession in the first quarter - or even in the last quarter of 2007 . Italy has suffered three recessions between 2001 and 2005. According to the IMF Italy will grow by 0.3 percent this year, half the pace of the U.S. and a fraction of the 1.2 percent growth rate anticipated for the entire euro region. Making this the 12th year in a row that Italian growth has been below the average rate for the euro-region.

Italian retail sales fell at the fastest pace in four years in March as campaigning for national elections drew to a close and added to concern about the economic outlook, the Bloomberg purchasing managers index showed.

Italian Retail Sales February 2008

Ok. I have to admit, the Italian National Statistics Office are not exactly my favourite institution. The most obvious recent issue I have with them is about why they have been (still) unable to supply us with comparable data Italian GDP for the last quarter of 2007 (oh, I know, the methodological revision and all that, the one everyone else seems to have already implemented without too much difficulty. My list of beefs would be a quite a long one, and indeed I would say the only EU country statistics website with which ISTAT compares favourably would be Bulgaria (and that really is saying something), while I much prefer the site's of some EU applicatnt members like Turkey (Turkstat) or even developing world emerging economies like Chile. My latest issue is with the retail sales data, which is listed month after month over at Eurostat with a "c" (which in theory means confidential, but afaiac could be read as "we can't or we won't give you comparable data", in either case the result is most lamentable). And the reason why this is the case is reasonably evident - since ISTAT (for whatever reason) don't publish constant price data for retail sales. The data we receive are normally at current prices which means they don't allow for the impact of inflation, which means that more money may be spent but the actual volume of sales may contract. And this explains a lot.

Take the latest announcement on retail sales, as published in the Wall Street Journal:

In Italy, the national statistics office Istat said retail sales, which aren't adjusted for inflation, rose 2.7% on the year in February after a 1.0% rise in January, while month-on-month they rose a seasonally adjusted 0.3% after a 0.2% rise in January. The statistics agency said sharp rises in fuel and commodity prices were behind the rise.

Now this gives the impression that somehow or other sales are rising - by 2.7% year on year, which wouldn't be bad. Indeed if we went back over the months we would get a chart for 2006 and 2007 that looked something like this:

Which is far from dynamic, but does give the impression that there is some life left in Italian retail activity. But if we stop for a minute and think about the fact that Italian CPI inflation was running at 3.1% in February we would discover (as a rough approximation, subtracting the CPI from the non inflation adjusted sales data) that Italian retail sales actually contracted by 0.4% year on year in February, and we would get a chart going back over the last couple of years that looked something like this:

which shows the near constant contraction which has been going on in the Italian retail sector despite the increase in employment and the decline in unemployment. Looking at things this way also solves another mystery: the apparent disparity between the ISTAT retail sales data (as commented on in the economic press) and the retail sales purchasing managers index, which regularly shows sales contracting.

German IFO Business Confidence April 2008

Business confidence in Germany (as measured by the IFO index) fell back in April (reinforcing the impression given by the recent ZEW index reading) as record oil and food prices stoked inflation, weakening further already weak domestic demand, and external conditions - and hence the outlook for exports - continued to deteriorate.

The Munich-based Ifo institute said its business climate index, which is based on a survey of 7,000 executives, fell to 102.4 from 104.8 in March. That's its lowest level since January 2006.

The sub component measuring German executives' assessment of the current business situation declined to 108.4 in April from 111.5 in March, while the indicator measuring expectations for future business dropped to 96.8 from 98.4.

Confidence also fell in France, with sentiment the among the 4,000 manufacturers surveyed by Insee, the Paris-based national statistics office, sliding to a 16-month low of 106 from 108.

In Italy, consumer confidence also held near its lowest level in four years, the Rome-based Isae Institute said today, while in Belgium, business sentiment dropped to the lowest level in more than two years in April.

A sharp slowdown in Europe will damp inflation and force the European Central Bank to cut interest rates within six months, the IMF's European Director, Michael Deppler, said earlier this week.

The ECB is reluctant to follow the U.S. Federal Reserve in cutting borrowing costs to bolster the economy, stressing its concern that inflation may get out of hand.

Food-price inflation in Europe accelerated to 6.2 percent in March from 5.8 percent in the previous month. That's the highest since the European Union's statistics office, Eurostat, began the current data series in 1997. The prices for rice, soybeans, wheat and corn have all risen to records this year. Crude oil also reached a record of $119.90 a barrel on April 22.

At the same time ECB policy makers including Germany's Axel Weber and Juergen Stark have suggested the ECB's current benchmark rate of 4 percent may not be high enough to combat inflation.

PMI Flash Estimates

The April preliminary estimate for the German purchasing managers index for manufacturing came in at 53.6 on Wednesday, significantly below economists' expectations of a 54.8 reading.

On the other hand, the services figure surprised on the upside with a figure of 54.6. The consensus had called for a reading of 51.6.

In March, the manufacturing and service PMIs came in at 51.8 and 55.1 respectively.

The euro zone composite PMI was recorded at 51.9, up from both the previous month’s reading of 51.8 and the expected reading of 51.5, but the eurozone manufacturing sector index, which brings together a number of indicators, dropped sharply, from 52 in March to 50.8.

According to a Danske Bank research note, the most conspicuous part of the euro zone PMI manufacturing results was the fall in the new orders index from 50.9 to 48.6, its lowest level in nearly three years.

Manufacturing new export orders contracted this month for the first time in almost three years, according to purchasing managers’ indices for the 15-country region. Even Germany, where overseas sales have appeared resilient, saw a sharp slowdown in growth rates.

“The effects of the euro are becoming increasingly widespread as long-term supply contracts are renegotiated,” said Chris Williamson at NTC Economics, which releases the figures with the Royal Bank of Scotland. So far, eurozone businesses, especially in Germany, have largely shrugged off the euro’s rise.

The results will worry policymakers because the effects of currency appreciation typically take many months to feed through. This week, the euro rose above $1.60 for the first time since its launch almost 10 years ago – suggesting a further slowdown in exports is in the pipeline.

France’s new export orders were already below 50 in March, but the latest figures for Germany showed a fall from 54 last month to 51.6 in April. The survey in-cludes trade between eurozone countries, but NTC Economics said responses by companies suggested the euro’s value was becoming increasingly an issue.

Germany's economy has performed relatively well in recent months. The economic slowdown is most pronounced in Spain and Italy, with France in between. Germany's overall PMI index rose to 55.0 in April from 53.0 in March. But the French composite PMI dropped to its lowest level since November 2004, dipping to 53.9 in April from 55.9 in March.

With a stubbornly elevated rate of inflation and a weaker rate of growth, the European Central Bank's policy dilemma is worsening, leaving the central bank's rate-setters with little room to maneuver.

The worsening outlook for manufacturing contrasted with bullish euro-zone industrial order inflow reported for February, when bookings rose 0.6% month-on-month and 9.9% year-on-year, according to Eurostat.

Wednesday, April 23, 2008

The French Economy - Acting As The Eurozone Buffer?

What really strikes me about the slowdown we are currently seeing in the eurozone economies is not so much what we are seeing, but how we are seeing (or if you like interpreting) it. The core of the issue is to be found - as is ever the case - in the details. And first and foremost among these details is the way in which inflation is so obviously crimping any attempt on the part of the ECB to use conventional monetary policy (namely lowering interest rates) to help the ailing Spanish (see here) and Italian (see here) economies. As a result the Sabre rattling continues in Frankfurt and the euro continues to move onwards and upwards, touching an all time high of $1.6019 yesterday (for a fuller exploration of some of the issues which arise here, see Claus Vistesen's recent The ECB - One Play-Book, One Page, One Purpose post).

It also doesn't seem to me to be without some significance that what sent the euro off upwards again yesterday was a comment from French Central Bank Governor Christian Noyer.

“Our big problem is to ensure that inflation returns below 2 per cent next year,” Christian Noyer told French radio. “If needed, we will move interest rates.”
What Noyer seems to be saying is that the French economy is weathering the storm, not only were exports up in February, but unemployment continues to fall, and industrial output continues to surprise on the upside, while the French services sector remained the one bright spot on an otherwise darkening eurozone horizon, at least according to the March reading of the Royal Bank of Scotland purchasing managers index. So it is the underlying strength of the French economy at the present time which is the real news behind the headlines of the record euro level we saw yesterday.

In fact the substantial appreciation in the value of the euro (which should have some kind of disinflationary pass-through impact) may well make an actual rise in ECB interest rates unlikely in the near future, but it is interesting to note that - in a significant turnround - the financial markets have started to price-in the slight possibility of an increase in ECB rates later this year. The ECB meanwhile mainatins the posture that the economic uncertainty surrounding the current outlook makes the direction of its next interest rate move unclear.

What really caught my eye this morning, however, was the following comment in the Financial Times:
France’s economic outlook could play an important role in the ECB’s thinking. Spain is facing a sharp housing market correction, while German economic growth is thought to have been surprisingly strong at the start of the year. “The fact that France is holding up in the middle is probably preventing eurozone [economic] numbers from moving significantly to the downside. It is a bit of a buffer,” said Jacques Cailloux at Royal Bank of Scotland.

France may be a bellwether for the eurozone because its relative resilience lies in the absence, so far, of a credit crunch or sharp slowdown in consumption.

Basically what is strange about all this is how it is precisely the French economy (in terms of the durability of its domestic consumption) that is really holoding things together in the eurozone right now (along with German exports - but NOT German consumption - of course). What is most striking from where I am sitting is how little thought all those big-name widely-quoted economists seem to be giving to the implications of what is happening. Claus Vistesen and I would argue - naturally - that the apparent resilience of the French consumer (how can I keep my head, when all around me are losing their's) has someting to do with France's comparatively favourable demographics. But perhaps others who do not share this view would also like to offer some sort of explanation - for reasons of intellectual self-respect if for no other reason.

Basically I find it hard to see - if I follow the standard explanations - how it is that an economy that everyone has spent the last five years or so trashing - for its labour market inefficiencies, its profligate government spending and its high level of state intervention - turns out to be doing just fine (or nearly so), while all around are starting to visibly wilt.

Obviously there is more to this story than simple demographics. The French banking system didn't invent its own version of the Spanish "cedulas hipotecarias", and wasn't offering such a huge percentage of variable mortgages, and wasn't offering so many 100% (or 110%) Loan to Value mortgages. That is the French banking system seems to have been more (or better) regulated (and that used to be a dirty word), and as a result isn't facing any imminent danger of fiancial meltdown since - desite having the same nominal interest rate as Spain - French householders were not sent of on a "buy one, and buy a second what while you're at it" housing spree of anything like the proportions which we have seen in Spain and Ireland. But again most commentators don't even seem to be even picking up on this part.

The roots of this recent renaissance of the French economy in economics discourse in fact go back to the autumn of last year, when the Financial Times ran a rather interesting story (see my original blog post here) which pointed out that:

"The size of the British economy has slipped below that of France for the first time since 1999 thanks to the slide in the value of the pound. Sterling’s rapid fall to 11-year lows against European currencies has also pushed Britain into sixth place in the world. The US, Japan, Germany, China and France all had larger economies than the UK in the third quarter of 2007."

Basically the facts behind the story are that in 2006 French GDP was worth €1,792bn compared with £1,304bn for the UK. With sterling worth €1.47 on average in 2006, this put the UK economy comfortably 6.7 per cent ahead of the French one. But with sterling on the slide - it has fallen by more than 10 per cent against the euro in the past six months (to the current €1.32 to the pound), the UK economy entering 2008 is now 4 per cent smaller than France's.

And again there is a bigger picture story behind the headlines here, one that has to do with the fact (as Claus Vistesen tried to sketch out here) that France, far from being the "sick man of Europe" in economic terms, and as a result of some very important underlying macroeconomic structural features, is now enjoying a new lease of life.

This view must surprise some people, since it is obviously a long way away from a lot of conventional wisdom which is being written on the matter. Basically, if you follow the institutional reforms discourse, then the UK should be streaking ahead of France following the latters failure to grasp the nettle and "reform" itself (something, please note, that the present author considers highly desireable in and of itself). But such reforms only focus on micro level phenomena, and do not take into account certain key macro economic trends, and in particular they seem almost never to take into account important macro level phenomena like comparative demographic shifts. What this means quite simply is that something here isn't being measured as it should be, and the outcome is bad results and bad forecasts.

This use of bad arguments (or at best partial ones) also makes it very difficult to persuade some people - in this case French voters - to do something that they are evidently very reluctant to do, and that is support the reform process. When your key argument is flawed, and you can't point to the benefits you would like to point to (even if in fact many of the reforms being proposed are quite necessary, especially in terms of the long term sustainability of the health and pensions systems). This peculiar situation was also recently highlighted by the move of those eternal "bette noires" of the international financial institutions - Argentina and Thailand - when they complained only last year to the world bank that since the normal "competitiveness" indexes were giving them very bad ratings, while at the same time their economies were putting in strong performances, then there must be something wrong with the indexes. I imagine they are still waiting for a coherent reply.

Basically the whole "institutional reforms" story is wrong, not because such micro level competitiveness-oriented reforms are unnecessary (they normally are), but because they are only part of the picture, and thus offer a very misleading perspective. A classic example of what I am talking about was also offered by the Financial Times's recommendations to Spain on how to solve the economic mess which the Spanish economy is now headed towards (incidentally, I would point out here that I have nothing against the Financial Times, and I am simply quoting their correspondents since they form part of what I consider to be a much more general problem..

Spain has been content to enjoy the benefits of cheap credit and strong European demand for its goods and services. Unlike France, it has not embarked on the structural reforms needed for longer lasting prosperity.

Mr Zapatero pretends these are not needed. But, if re-elected, he should rethink. Generous tax cuts should be avoided in order to maintain a mildly restrictive fiscal stance. Measures to foster competitiveness are essential. These should include dismantling barriers to competition in retailing, transport and energy. He should ditch a preference for national champions.

Persistent weakness in productivity growth must be addressed too. Recent steps to expand Spain’s small technology base, promote entrepreneurship and bolster its ossified education system are positive. But universities need more independence. Allowing companies to opt out of collective wage deals would make the labour market more flexible. This is far from a comprehensive manifesto. But it is the least Spain must do if it is to remain one of Europe’s pacesetters

Now I think we could pass quietly over the little detail that France is now being cited as a country which is benefiting from structural reform. What is notable about the kind of "rescue package" being proposed for Spain is that it is largely ignores the substantial underlying macro economic questions which are in play - like the health of the banking system, some evaluation of the impact of "financial efficiencies", interest rate policy at the ECB, the value of the euro, the presence of five million immigrants (who have largely arrived over the last 6 or 7 years at just the same time as the current account deficit - which the FT does mention -has balooned), the role of the eurosystem and covered bonds in making cheap interest loans available at what were effectively negative real interest rates, etc, etc, etc.

Evidentaly non of this is directly Mr Zapatero's fault, any more than it was Mr Aznar's fault. This is not the moment to attempt a fuller analysis of Spain's current problems - you can find a first attempt at getting to grips with these here. Rather my objective is to point out that basing yourself on micro economic analysis alone you will never get to the heart of major economic issues which face us. And this is what the current mainstream economic discourse seems to do, spilling in the process an excessive amount of ink about shop opening hours, flexible labour contracts, and privatisation of "national champions" (all of which, please note, may well be a good idea, but I can tell you now, none of these are going to get Spain out of the problem which is about to arrive, nor, for that matter, will they prevent the inflation bonfire from currently roaring away in Eastern Europe which I was drawing attention to in my Slovakia post yesterday).

Monday, April 21, 2008

German Government Ups It's Growth Forcecast For Q1 2008

The Finance Ministry have announced this morning that the German economy may have expanded at a stronger pace in the first three months of 2008 than was expected earlier. Sine they must already have some provisional data to hand this outcome now seems very likely. It should also come as no particular surprise to regular readers of this blog since we have been closely following industrial outputand export numbers and the pattern of resistance to the general downward movement globally has been clear enough.

However the Ministry also indicate that the economic data they have to hand suggest that growth will moderate in the course of this year. Again we concur, and suggest that the key data to watch moving forward are the rate of export growth and investment in machinery and equipment, once both of these start to fall back the deceleration will become much more pronounced.

"Economic growth forces still prevail,'' the Berlin-based ministry said today in its monthly report, citing ``favorable economic fundamental data, robust domestic demand, above-average capacity utilization as well as optimistic sentiment at companies.'' Still, economic risks such as rising oil prices, the euro's appreciation and a recession in the U.S. have increased, and slowing orders may be a sign of ``brake marks'' caused by less dynamic global growth, the ministry said.

The Ministry report is the second government study in four days to suggest that the German economy, which is still Europe's largest, may be hurt over time by cooling of world trade. The Economy Ministry said on April 18 that economic growth will likely moderate after an acceleration in the first quarter as the outlook for exports darkens "in the short term.''

The Ministry noted that sluggish consumer spending was a "concern" and it is reasonably clear that slowing exports - when this situation arrives - will not be compensated by higher internal demand.

German manufacturing orders unexpectedly fell for a third month in February, the Economy Ministry said April 4. Adjusted for seasonal swings and inflation, orders fell 0.5 percent.

Tuesday, April 15, 2008

German Investor Confidence Slips

Following Claus's excellent tour de force yesterday on the various level's of double-bind that now seem to be facing the ECB, I'd just like to chip in to the overall picture with a bit of country level detail. Investor confidence in Germany fell in April for the first time since January on concern that faster inflation, a stronger euro and fallout on exports from slowing economies in Italy (see detailed analysis here) and Spain (see here) will hurt company earnings. The ZEW Center for European Economic Research said yesterday that its index of investor and analyst expectations declined to minus 40.7 from minus 32 in March. This was just above the 15-year low of minus 41.6 it in January.

The euro dropped more than half a cent to $1.5828 at 11:06 a.m. in Frankfurt following release of the report while the DAX index retreated as much as 25 points to an intra-day low of 6532.76. Germany's benchmark DAX share index has dropped 19 percent this year, the biggest decline among major European stock markets, as investors grow steadily more nervous about the robustness of the German economy to the increasing difficulties which are encircling it - "am I to be the one to keep my head when all those around me are losing theirs?". So while in real data terms growth in Europe's largest economy still seems to be holding up, the outlook is now evidently deteriorating.

In a further indication of the steadily changing conditions the German Credit Reform agency reported on April 1 that aroun a third of medium-sized German companies are already finding it more difficult to get loans. And at the interbank level the cost of borrowing euros for three months rose to 4.75 percent on Monday, the highest level since Dec. 27.

Services PMI

The rate of expansion in German services growth slowed a little in March, as the services purchasing managers index dropping to 51.8 from 52.2 in February. Still German services continue to expand, and this gives us one measure of the extent to which the German economy had up to now shown itself able to resist. The rate of expansion is now much weaker than before August 2007, but there is still expansion.

Industrial Output

German industrial production has also proved reasonably robust in recent months and rose one more time in February, giving its third monthly gain in as many months, as manufacturing output continued to hold up and unusually warm temperatures boosted construction. Output rose a seasonally adjusted 0.4 percent from January, when it gained 1.4 percent, the Economy Ministry in Berlin said last week. Year on year total industrial production was up 6.1 percent when adjusted for the number of working days.

Construction output also rose in February - up 3.7 percent on the month. Manufacturing production increased 0.3 percent and output of semi-finished goods rose 1.6 percent. Investment goods production however declined by 0.2 percent month on month.

Retail Sales

German retail sales, however, had their biggest month on month fall in almost a year in February as faster inflation eroded consumer spending power. Sales, adjusted for inflation and seasonal swings, fell 1.6 percent from January, according to data from the Federal Statistics Office. That's the biggest drop since May 2007.

According to provisional results of the Federal Statistical Office, in February 2008 turnover in the German retail trade was up in money terms by 2.4% and down in real inflation adjusted terms by 0.3% over February 2007. There was even one extra shopping day in February 2008 (25) as compared with February 2007 (24).

So German consumption is a long way from driving the German economy forward at this point.

Then There Is Inflation

Companies and consumers are also hard at it grappling with higher energy and food prices, which drove Germany's inflation rate to 3.2 percent last month. Crude oil prices have climbed 76 percent over the past year, reaching a record $114.95 today.


So what we have left here are exports, which are reflected in those steady industrial output numbers, and on the plus side German exports in February remained unchanged from January, suggesting that Europe's largest economy continued at that point to resist the force of the global slowdown and the rise in the euro, but adding export on-top-of export may now be getting to be a harder and harder thing to do. Even more to the point, a change in the distribution of German exports is taking place on the margin, since while the pace of expansion to EU countries slowed from 7.7% in January to 6.7% in February, the pace of expansion to non EU countries (and we could think here in particular of Russia perhaps) rose from 11.5% in January to 13.5% in February. So rising demand in Russia (and to a lesser extent China) is making up for declining demand from Spain and Italy as these economies slow. All of this is now a delicate balancing act, and we will need to watch carefully what happens in March and April.

German sales abroad, when adjusted for working days and seasonal changes, were unchanged in February from January, when they rose 3.6 percent. Imports were down a seasonally adjusted 0.4% from January, reflecting the fact that internal demand in Gemany could hardly be called "vibrant" at the present time. Exports rose 9 percent year on year, while imports were up 7%.

What really matters about German exports is their general distribution and comparative rates of growth. The numbers for China were up from 27,520.6 million euro in 2006 to 29,922.7 million euro in 2007, an incease of only 2,402.1 million Euro (or 8.7%) while exports to the Czech Republic went up from 22,255.3 million euro in 2006 to 26,026.6 million euro in 2007, an incease of 3,771.3 million Euro, or 16.8% (proportionatley about double the Chinese increase at). So we can say that the Czech Republic is just about as important a customer for Germany as China is, and more importantly Germany has more vulnerability to economic slowdown in the Czech Republic than it does to one in China.

The United States has been declining in importance for German exports, and is down from 78,011.4 million euro in 2006 to 73,356.0 million euro in 2007, that is a decrease of 4,655.4 million Euro or 6%. Poland on the other hand is way up - from 28,820,4 million euro in 2006 to 36,083.2 million euro in 2007, that is an increase of 7,262.8 million Euro or 25.2%. Hungary is also up - from 15,870.8 million euro in 2006 to 17304.9 mi,llion euro in 2007, that is an increase of 1,434.9 million Euro or 9%.

So another way of looking at this is that Poland, the Czech Republic and Hungary between them are now - at 79,414.7 million euro in 2007 - more for German exports than the United States - with 73,356 million euro in 2007 - is, which I think is really quite incredible.

Spain was up from 42,159.2 million euro in 2006 to 48,157.7 million euro in 2007, an increase of 5,998.5 million Euro or 14.2%, while Italy was up from 59,971.4 million euro in 2006 to 65,148.0 million euro in 2007, an increase of 5,176.6 million Euro or 8.5%. Again Spain and Italy are also between them more important for Germany than the US is, and it is of course these two economies that are now slowing significantly.

The Russian Federation on the other hand continues to expand rapidly, and was up from 23,371.8 million euro in 2006 to 28,185.2 million euro in 2007, an increase of 4,813.4 million Euro or 20.6%.

Now Hungary is a rather interesting case in point here, since it has a fairly open economy with external trade (exports plus imports) now representing 155% of gross domestic product. Hungary is also itself increasingly dependent on exports, since there is a recession in internal demand following the introduction of an austerity programme in the autumn of 2006. And, guess what, Hungarian trade is incredibly interlinked with Germany, and nearly 30% of Hungarian exports now go to Germany.

Also Hungary's industrial output has been doing pretty well over the last couple of months, jumping by 9.8% over February 2007 on a working day adjusted basis. Output also increased reasonably well in January, following rather weaker numbers in November and December, numbers which really rather mirror what was happening in Germany at the time.

If we look at the chart for Polish industrial output, we can again see a surge in February, with industrial output at an annual 14.9 percent rate, up from 10.8 percent in January.

And again the Czech republic looks pretty similar, with industrial output growing by 11.3 percent year-on-year in February, compared to a 9.3 percent rate in January.

Curiously, and I'm not sure at this point whether this is simply a coincidence or not, the central banks in all these three countries have been busy raising base rates in recent months.

On the other hand this recent acceleration is unlikely to be of long duration. We may see the surge continue, but I doubt it will run many more month after that, and I read the ZEW index reading in just this sense. In addition German manufacturing orders declined for the third consecutive month in February. Orders,adjusted for seasonal swings and inflation, fell 0.5 percent from January, when they dropped 0.7 percent, the Economy and Technology Ministry said earlier this month. Export orders were down 1.1 percent in February from January while domestic orders were unchanged.. In the first two months of the year, orders fell 1.5 percent from the previous two-month period.

Also if we come to look at Hungarian order books we will find a rather similar picture in that total new orders for industry were down 5.3% year on year in February as compared with a decline of only 2.5% in January . In particular new exports orders fell by 4.2% year on year (which compares with a 0.8% year on year gain in January). Eszter Gárgyán, from Citibank, Budapest - quoted in Portfolio Hungary - is pretty much to the point on all of this:

“The latest Euro Area economic indicators were surprisingly strong, suggesting that Hungary's main export partner (Germany) is so far in good shape and that the effects of the US slow down and rising credit costs are limited. We expect a broader Euro Area weakness in the second half of the year, which is likely to limit the Hungarian growth recovery due to weaker net exports."
And as Hungary goes, so goes Germany - or vice versa if you prefer, since the level of circular causality running through German growth and growth in the East European economies we have been looking at is now very strong indeed.

Where Do We Go From Here?

My personal feeling is that the German economy data now needs watching very carefully indeed. The weakness is evident, despite the valiant effort we have seen to hang on in there. The slowdown in Italy and Spain will undoubtedly take a toll on exports, and possibly the UK will act as a drag too. I don't think it needs too much change in export growth on the margin to start to tip this all over, since export driven economies are often not the most stable of beasts.

The next key data point will be the manufacturing purchasing managers index reading for April which is due out at the start of May. This should tell us a lot about what is happening NOW, as opposed to what was happening two or three months ago. In the world of macroeconomics these days a month, and even a week, is often a long time.

The International Monetary Fund last week cut its prediction for German economic growth this year to 1.4 percent from 1.6 percent, and recommended the European Central Bank start cutting interest rates. This view has so far been frowned on in Berlin and over at the ECB German, with most notably German Finance Minister Peer Steinbrueck saying he sees no need to "correct our growth expectation'" for 2008 of 1.7 percent, and Bundesbank President and ECB council member Axel Weber informing the press that "I don't share the International Monetary Fund's pessimistic view.''

Far from the IMF being "pessimistic" I think there are strong downside risks to the IMF forecast, and especially if problems start to emerge in those Eastern European economies on which Germany is now, as we have seen, very dependent for export growth.

France Inflation March 2008

French inflation accelerated more than many economists anticipated in March, reaching the fastest pace in at least 12 years and underscoring the European Central Bank's reluctance to cut interest rates.

Consumer prices climbed by an annual 3.5 percent, up from a rate of 3.2 percent in February, based on European Union- harmonized methods, Insee, the national statistics bureau, said today in Paris. That's the fastest pace since 1996, when Insee began reporting the data, and matched the euro region's rate. Prices increased 0.8 percent from February, which was also the biggest monthly gain on record.

French energy prices increased 2.7 percent on the month and 12.7 percent from a year earlier. Food costs rose 0.4 percent from February and 5.3 percent on the year, today's report showed. Services such as health care and transport added 0.2 percent in March from the previous month, and the cost of manufactured goods climbed 1.2 percent, Insee said.

ECB policy makers including Yves Mersch, Juergen Stark and Axel Weber have rebuffed a call by the International Monetary Fund to follow the U.S. Federal Reserve and the Bank of England in cutting rates to bolster economic growth. The Frankfurt-based ECB last week left its benchmark rate at a six-year high of 4 percent, even as a looming U.S. recession, record oil prices and the euro appreciation threaten to choke economic expansion.

Following the news investors raised bets that the ECB would stand pat through 2008. The yield on December interest-rate futures rose to 4.18 percent from 4.14 percent yesterday.

Saturday, April 12, 2008

Italy's Economy Going Into The 2008 General Election

As Italians head to the polls this weekend in order to pick what will be their 62nd government in 65 years (in an election which is being held three years early to boot, due to the collapse of Romano Prodi's outgoing administration) one odd detail seems to stand out and sum up the multitude of political and economic woes which confront Italy at the present time: we still don't have economic growth figures for the last quarter of 2007. Now this situation may well be an entirely fortuitous one - Italy's national statistics office ISTAT are in the process of introducing a new methodology to bring their data into line with current EU standards as employed in other countries (Italy yet one more time is at the end of the line here, but let's not get bogged down on this detail) - but there does seem to be something deeply symbolic about all this, especially since Italy may well currently be in recession, and may well be the first eurozone country to have fallen into recession since the global financial turmoil of August 2007.

Perhaps the other salient detail on this election weekend is the news this (Saturday) morning that "national champion" airline Alitalia is near to collapse and may have its license to fly revoked, at least this is the view of Vito Riggio, president of Italy's civil aviation authority, as reported in Corriere della Sera.

"If something isn't done soon, everyone must realize that Alitalia is on its last legs.... The authority will have no choice but to revoke the airline's license ``in two, maximum three weeks if it can't show it can find cash to stay in business"
And as if to add insult to injury, only this week the IMF revised down yet one more their 2008 forecast for Italian GDP growth, on this occasion to a mere 0.3% - and (as we will see below) a steadily accumulating body of data now clearly suggest that Italy is probably already in recession, and may well have entered recession sometime during the last quarter of 2007. If confirmed this will mean that Italy will have been in and out of four recessions in last five years. So perhaps the real question we should be asking ourselves is not be whether Italy is in a recession, but when in fact she enter it, and even more to the point, when will she leave?

``Italy and its economy are like the Titanic hitting the iceberg,'' said Gianni De Michelis, deputy prime minister in 1988 and 1989. ``It's gotten to this stage after years of negligent governments on both sides. Berlusconi or Veltroni? It makes no difference.''

It should be plain from the above long term growth chart that the problems Italy is facing are not mere conjunctural (cyclical) ones. Deep structural processes are now obviously at work, and Italy is now in danger of spending more time in rcession than she actually spends out of one, a position which has some similarities with the Japanese lost decade - the so called Heisei recession - of the late 1990s and early 2000s. And this comparison may not be entirely accidental since, as we shall see below, Japan and Italy are two of the planets three (along with Germany) oldest societies.

But first let's take a look at some of the evidence that Italy may well now be in recession.

Retail Sales

Italian retail sales fell through the floor in March - at least according to the Bloomberg NTC Purchasing Managers Index - with sales being registered as falling at the fastest pace in four years. The seasonally adjusted index of retail sales declined to 36.4 from 43.8 in February, the lowest rating shown by any country since the survey began in January 2004. The reading on this particular index has now been below 50, the level that signals a contraction in sales, since February 2007.

In January (which is the latest month for which we have data) retail sales in Italy were up year on year by 1% according to data from the National Statistics Office (ISTAT). While the values on the two measures are a little different, with ISTAT figures being notably a little more volatile, the general downward trend in the rate of new activity since mid 2006 is still noteable in the chart.

A further indication about the current state of mind of the Italian consumer can be found in Italy's new car sales, which fell for a third straight month in March - down 18.76 percent - year on year. Sales of Fiat's three brands suffered an even harder fall of 20.6 percent. Registrations of new car sales totalled 212,326 in March against 261,370 for the same period last year. Those for cars of the three brands belonging to the Fiat group totalled 65,594 against 82,649 in March 2007. Fiat's share of registrations in what is its home market was 30.89 percent.

If we look at car sales across the first quarter taken as a whole then we find the total number of sales registered with the transport ministry was - at 663,532 - down 10.01 percent on the first quarter of 2007. This seems to suggest that the situation deteriorated dramatically between January and March, a finding which is entirely consistent with the shocking retail PMI reading for March.

Household spending, which makes up two-thirds of Italy's economy, was slowing throughout 2007, only growing very slightly (by 0.2 percent) between the second and third quarters, a rate which was down when compared with the 0.5 percent rise achieved in the second quarter over the fisrt, or the 0.7% one in the first quarter over the fourth quarter of 2006.

Indeed what we neem to note is that Italian domestic consumption, despite the considerable increase in the working population via immigration and the low levels of unemployment registered recently, is now congenitally weak, and only twice since the start of 2003 - during the rather exceptional Q1 and Q2 2007 - has the rate of increased broken through the 2% year on year threshold.

So Italian household consumption has remained unmovingly weak over a number of years now, and this weaknes rather took me by surprise, I must admit, when I first became aware of it, since it so closely mirrors what we have been seeing in Germany and Japan, where again, and despite extensive labour market reforms and extensive job creation domestic consumers have not been able to drive the economies. Due to the similarity in the structural components here between Germany, Japan and Italy (with Italy's weaker export performance being the only real distinguishing feature, indeed you might almost call Italy Germany and Japan without the export prowess) Claus Vistesen and I are arguing that the whole phenomenon is ageing related, since these three societies - with median population ages pushing the 43 mark - are now the oldest on the planet.

Industrial Output

If we now turn to Italian industrial output we find that this declined in February - the most recent month for which we have data from ISTAT - as the worsening economic outlook reduced demand for manufactured products. Production dropped 0.2 percent after rising a revised 1.2 percent in January. The seasonally and working day adjusted output index dropped back to 97.8 from 98.3 in January.

Year on year (and working day corrected) output was down 0.8% over February 2007. Production of Italian consumer goods fell 2.6 percent from January as the output of durable goods like refrigerators declined 0.6 percent with non-durable goods contracting 2.6 percent. The only gain came in energy related goods, which rose 0.5 percent.

Part of the decline in output may have been caused by the plunge in car production, which fell 24 percent from a year earlier on a non-adjusted basis. Istat did not give car output figures comparing February with January. Production of all vehicles - including trucks and busses - declined 3.2 percent from a year earlier on a non-adjusted basis.

If we look at the purchasing managers index and observe the chart (below) we can find the same general picture with the rate of expansion slowing from mid summer, and the index actually registering month on month contraction in March (49.4) for the first time in nearly three years, suggesting that output slowed to stagnation as exports decline.

"The slowdown largely reflected a fall in new orders from both domestic and foreign markets. Operating conditions were further worsened by the fastest rate of cost inflation for 20 months," NTC/ADACI said. NTC Research chief economist Chris Williamson said the figures were consistent with stagnation in the first quarter and added there could be a worsening in the second quarter given the fall in new orders.


Italy's service sector also seems to have contracted in March - for the fourth consecutive month - though the rate of contraction did drop back from February's record rate, as employment fell and input prices rose at their fastest pace on record, according to the latest NTC/ADACI survey. The NTC Research Purchasing Managers Index, which covers companies ranging from hotels to insurance brokers, rose to 48.8 from February's 47.2. Despite the recovery from February's all-time low, March's reading remained below the 50 divide between growth and contraction for the fourth consecutive month.

If we add all of this - retail sales, industrial output, services activity - together it is hard not to draw the conclusion that Italy is now in recession.

"These figures, coupled with the manufacturing PMI, suggest Italy's economy has started to contract," said Chris Williamson, chief economist at NTC Research which compiles the data. "It's hard to see any silver lining and it doesn't seem the worst is over by any means," he said, forecasting Italian gross domestic product fell 0.1 percent in the first quarter.

Sentiment Indexes

If we now turn to the sentiment indexes, a similar picture emerges. The European Commission recently reported its eurozone “economic sentiment” indicator for March, with the composite number for the whole region bouncing back a little from the February reading which its lowest level since December 2005.

The indicator, which gauges optimism across all economic sectors and is regarded as a good guide to likely future trends, was back up to 102 after falling to 100.1 in February from 101.7 in January. However the picture is a mixed one (see chart below), with Germany for the time being holding reasonably stable (and climbing back to 104 from 103.7 in February), France also holding up fairly well at 105.6 (up from 105.2 in February), while Ireland continues to hover near the brink, Italy continues its steady downward path, and Spain heads straight off the map. (the March reading in Spain was 83.9 which was down from 87.5 in February). I suppose in the Spanish case it is now simply a question of how low can you go before you hit bottom.

Maybe for Italy at least there some consolation here, since bad as they are, they are far from being the worst case scenario at this point. This, however, is precious little in the way of consolation. And especially not when we start to think about all those government debt financing issues which are looming just round the next corner.

At the same time Italian business confidence declined to its lowest level in two and a half years in March as slowing economic growth and the euro's appreciation continued to weigh on orders and optimism. The Isae Institute's business confidence index fell to 89, the lowest since August 2005, from a revised 89.6 in February, according to the Rome-based research centre earlier in the month.

Worthy of note was also the fact that a sub-index measuring Italian manufacturers' total orders fell to minus 16 from minus 13. Exporters are currently pretty pessimistic about their short-term sales outlook, with the relevant sub-component falling to 5 from 9 last month, according to a recent quarterly survey of exporters.

``The fall in confidence is due above all to the contraction in orders,'' Isae
said. ``In the first quarter of 2008, both current exports and the outlook for
exports worsened.''

Italian consumer confidence falso fell in March - in this case to its lowest level in nearly four years, as rising prices and slowing economic growth increased pessimism among growing numbers of Italians. The Rome-based Isae Institute's index, based on a survey of 2,000 families, fell to 99 from a revised 102.8 in February. This reading is the lowest since May 2004.

Italians have been steadily cutting back on their spending, which makes up two-thirds of the economy, as the continuing rise in the cost of food and transportation reduces their disposable income. ISAE is currently predicting that the Italian economy will grow by as little as 0.5 percent this year, the slowest pace since 2003.

Again some of the details here are really quite striking, since the sub component concerning optimism about the current economic situation fell to a 14-year low of minus 132 from minus 118 in February, and the number of Italians who are "very concerned'' about rising prices is at a four-year high.

Obviously overhanging the whole economic climate is the current election campaign, which was triggered by the collapse of Prime Minister Romano Prodi's government in January after 20 months in power. Both leading candidates, two-time premier Silvio Berlusconi and former Rome Mayor Walter Veltroni, are promising tax cuts to help revive growth, although given the large fiscal constraints that this growth slowdown will present, it is far from clear where any of these will come from and more than likely most consumers interviewed were only too well aware of this when forming their assessment.

Italian Inflation

On the other hand the news on the inflation front is not good at all. According to the latest ISTAT data Italy's inflation rate rose in March to the highest level in more than 11 years, driven by gains in energy prices and a surge in the cost of food and housing. Consumer prices calculated by European Union's harmonised index rose 3.6 percent from March 2007, an increase on February's rate of l3.1 percent. The February reading had previously been the highest rate since the index was created in January 1997.

Consumer prices rose 1.6 percent in March from February, which is a very rapid rate indeed (annualised 18%). The rate of price increases has clearly accelerated and Italy - which given the very low (or even negative) rate of economic growth which exists at this point - could be said to be suffering from some variant of stagflation. This will not make it at all easy for the ECB to bring any kind of early reflief in the form of rate cuts (which could be just as important for their impact on the current high value of the euro which is crimping Italian exports, as for any easing of lending conditions) in the near future.

Employment and Unemployment

The one bright star in the Italian economic firmament in recent months has been employment. The Italian unemployment rate has been steadily falling since the last quarter of 2004, and in the last quarter of 2007 it stood at 6 percent, its lowest level since 1993.

However these record-low unemployment rates in Italy mask significant regional disparities in joblessness. The jobless rate in Italy's industrial north was 3.4 percent in the fourth quarter, compared with almost 11 percent in the mezzogiorno (south of the country).

Italian unemployment has in fact declined steadily since 1999 after the introduction of changes in labour market regulations which effectively made it easier for companies to hire part-time and temporary workers who don't enjoy the same benefits and job security as full-time staff and can be more easily fired when financial constraints force cuts. This flexibility in the ease of hiring and firing is also reflected in the data, since the number of full-time workers with temporary contracts fell year on year in the last quarter of 2007 for the first time in at least three years, indicating that as the Italian economy slowed these were the first workers to go.

Part time working has also grown steadily since the reform, and nearly 1 in 4 jobs in Italy are now either part time or temporary.

And growth in temporary and part time working has been especially pronounced among the over 35 age group. Unfortunately ISTAT don't provide detailed enough data here, but I think it would be reasonable enough to assume that a significant share of these workers are over 50, since stable employment participation rates in the 35 to 50 age group are traditionally high, so there is not a big pool of workers waiting around to be "sucked into" employment during times of economic expansion.

Moreover, after many years of very low fertility, fewer and fewer young Italians are now joining the workforce to replace the older Italians who are retiring, and their places are now being taken by a steady stream of newly arrived immigrants. In fact two-thirds of the annual increase of 308,000 new workers in the fourth quarter were immigrants, with the other third being effectively accounted for by an increase in employment rates in the 55 to 64 age group. So yet one more time we find a significant difference between what has been going on in Italy and comparable countires experiencing rapid population ageing - Japan and Germany - since while all three countries have leveraged labour reforms to increase job creation, and in all three economies unemployment has been falling steadily, in Germany and Japan this increased employment has been achieved by substantial icreases in the over 55 age group employment participation rates (for developments in Japan see this post here, and for Germany see this one), in Italy - given the ongoing failure to reach agreement on substantial increases in the retirement age and the inability to convince the general population that the problem is an urgent one - a very large share of the new employment has gone to immigrants, who are effectively working to pay a significant chunk of the pensions bill being run up by all of those who are still retiring at 58.

Last November Prodi finally managed to get the support of Italy's labour unions for the 2008 budget by accepting a much more gradual pace of increase in Italy's pension and retirement age as a trade off. The agreement he reached involved a staggered increase in the minimum retirement age, which at that point was set at 57. The change in fact involved supplanting (or going back on) a previously agreed reform law - one which would have boosted the retirement age to 60 from as early as January 2008 - and an effective slowing down of the reform process. The law which was put aside was agreed to in 2004, by one of Silvio Berlusconi's governments, and the decision taken then had been to raise the minimum retirement age— from 57 to 60 - as of January 2008. Under the new Prodi plan the retirement age was raised by one year, to 58, in 2008. In July 2009 the retirement age will again go up, this time to 60 for those with 35 years of contributions, or remain the same for those workers who can muster 36 years of pension payments. From 2011, the retirement age for everyone will rise to 60, and then to 61 by 2013.

This decision, apart from being an astonishing one for outside observers, raises a number of important issues, especially since the ageing population problem is one which affects Italy in a very important way. Male life expectancy in Italy is now fast approaching 80, and is among the highest in the EU. At the same time Italy currently has the third-lowest birth rate in the EU (TFR around 1.3). Without raising the retirement age, contributions simply won't keep pace with pension payments over the coming years, even assuming there is no ageing impact on the overall economic growth rate, which as we are seeing is far from clear.

Of course doing things like this is totally unsustainable. Italy undoubtedly needs migrant labour, but as a complement to, and not a replacement for, a very substantial and swift increase in the retirement age and in employment participation rates among the over 60s.

The regional disequilibrium in Italy also seems to be becoming quite important again (just like the East-West one in Germany, and Tokyo vs the rest one in Japan). While the national participation rate for the 55 to 64 age group went up from 28.9% in Q1 2004 to 33% in Q3 2007, in the mezzogiorno it has gone up from 31.8 to 35.3 over the samer period, so the South is keeping pace here, but if we look at the 65 plus group, while participation has gone from 3.4% to 4% nationally over the same period, in the mezzogiorno it has gone DOWN from 2.4 to 2.1%. The 15 to 64 participation rate also dropped from 54.1 to 52.5 over the period in the mezzogiorno while in the North it went up from 67.8 to 69.2 %. And this situation is reflected in the relative job creation performance between the North and the South.

Basically, given the very strong fiscal pressure which is about to come in Italy, and the danger of a possible sovereign default at some point, if nothing is done to correct the underlying weak national growth trajectory, Italy can be almost literally torn apart by this type of disequilibrium, especially given that it is reinforced by the unequal distribution of migrants (see chart below, the migrants are overwhelmingly concentrated in the North and North East of the country). We thus have an ongoing polarisation of wealth, employment and people, and we really aren't giving sufficient consideration to the longer term political implications of the underlying economo-demographic process.

If you look at the chart below (which is, I admit, a slightly illegitimate one - but only slightly so - since I have derived it by subtracting the number of foreign workers and the number of workers from 55 to 64 from total employment, and some - even if very few for their age profile - migrant workers are in the 55 to 64 age group) we can see that the number of under 55 year old Italians in the workforce has been virtually stationary during the last two years, years of comparatively strong economic growth (in Italian terms) and record low unemployment. I think it is very easy to see some sort of ageing population effect in all this.

So, where does that leave us? Well with a not especially strong underlying labour market dynamic I would say. Employment is being created, but not specifically in high value work. New employment is, as I say, increasingly of low skilled immigrant workers, and part time or temporary workers in the over 50 (and indeed over 60) age group. And all of this despite the evident progress that has been made in bringing down unemployment. Basically the Italian economy is creating employment, but it isn't creating productivity, and it isn't creation strong expansions in consumption. And again, if you take a long, hard and cold look at these numbers I think it isn't too hard to see some of the reasons which help to explain why Italy is suffering from the rather weak consumption and low productivity growth.

Italy's Trade Deficit

Given that Italian domestic consumption remains weak, exports - and with them the value of the euro - take on a special significance. As opposed to other ageing and export dependent economies like Germany and Japan, Italy runs both a trade and a current account deficit. In 2007 the trade deficit was running at a rate of 9.5 billion euros, although this was down substantially from the record deficit of 20.5 billion euros in 2006. The improvement in 2007 was largely due to an improvement in export performance, since Italian exports were up by 8% while imports were only up by 4.4% during the year. Italy has been running a current account deficit since 2000, and evidently a significant part of the instability in Italian economic growth since the turn of the century is attributable to this single detail (given that Italy is an export dependent economy). If we look at the chart below it is evident that as the current account situation has deteriorated economic growth has become more and more fragile. This is not simply because Italy has not reformed sufficiently and has become uncompetitive (the standard explanation, which is of course the case), but because in the context of a rapidly ageing population it is the lack of "gusto" in domestic consumption which makes the whole position so unstable (the part the standard explanation normally misses, and what separates Italy from other - younger - current account deficit running economies like Spain, which is surely hardly any more "competitive" at the export level, indeed arguably it is a lot less so, as we may be about to see as the housing boom steadily disintegrates).

In general Italy maintains a trade surplus with the other countries in the European Union (5.7 billion euros in 2007, up from 210 million in 2006), and the lions share of the trade deficit comes from commerce with the rest of the world, of which of course energy forms an important part. The deficit is important, since with the continuing very sub-par growth in domestic consumption, economic growth - and with it the sustainability of public finances - very much depends on export performance, and indeed Italy will only be able to achieve stable economic growth by running a sustained and sizeable trade suplus.

In fact Italy narrowed its trade deficit with non-European Union countries in February, boosted by exports of refined petrol and machinery and a slight improvement in exports to the U.S. according to the most recent data from Istat. Italy's trade deficit with non-E.U. countries was 1.33 billion euros in February, which compared with a 1.74 billion deficit in February 2007. Exports to countries outside the E.U. thus rose 17.7% year on year to 12.88 billion euros, while imports from non-E.U. countries increased 12% to 14.21 billion euros.

Istat said the improvement was driven in large part by exports of refined petrol products and machinery and mechanical appliances, which rose 67.8% and 27.8% respectively.

Exports to the U.S. rose 10%, while imports from the U.S. increased 2.4%. Imports from the OPEC countries, which account for 9.3% of Italy's total imports, rose 33% on the year. Imports from China, which alone now constitute nearly 6% of the import total, rose 8.4%, while exports to China were up 20.1%. The narrowing of Italy's trade deficit with non-E.U. countries in February offers some support to the view that exports may well rebound modestly in the first quarter of the 2008, offering a little support to what is otherwise bound to be a very weak GDP growth number.

In January, which is the last month for which we have total trade data, Italy had a trade deficit of 4.22 billion euros, compared with a deficit of 3.69 billion euros a year earlier. Exports rose 12% year on year and 4.9% month on month, while imports rose 12.3% year on year and 1.7% month on month.

Italy's trade surplus with other European Union countries slowed in January, to EUR125 million euros, which compared with a surplus of 619 million euros in January 2007, as exports slid 1.3% on the month, but rose 8% on the year. Imports rose 11.8% on the year and 0.8% on the month.

In general it is the persistent inability of Italy's export sector to compensate for the lack of strong internal demand growth which makes the path of Italian GDP so unstable.

Is Italy In Recession?

Italy's economy will expand in 2008 at the slowest pace in five years as "external shocks" such as record oil prices and the strong euro impact consumers and businesses, according to the most recent report from Italy's leading ISAE research institute.. The institute now predict that the Italian economy will grow by only 0.5 percent this year. That's down from their October forecast of 1.4 percent and if realised will be the weakest Italian growth rate since 2003.

Italy's Finance Ministry, on the other hand, still expect growth of 0.6 percent this year, the European Commission expect a rate of 0.7%, while Confindustria, Italy's largest employers' group, has cut its forecast to 0 percent.

The International Monetary Fund cut its Italian growth forecast to 0.3 percent for this year and the next, making Italy the worst-performing economy among the Group of Seven nations and the 15 countries sharing the euro.

Italy is thus topping lists worldwide as the developed economy in the worst shape. The country came last in terms of labor productivity - a key measure of economic growth and competitiveness - in a recent inter-country comparison carried out by the 30-member Organization for Economic Cooperation and Development. No other developed economy has been through three recessions in five years (now heading into its fourth) and the country is coming to look more and more like the Japan of the "lost decade" - even down to the huge increase in the government debt to GDP ratio. It is clear that Italy is now saddled with a whole plethora of economic problems that are holding it back, not the least of them its loss of overall competitiveness.

Watch Out, Here Come The Ratings Agencies

Whoever wins the election, Italy's new government's ability to stimulate the economy with tax cuts (or any sort of fiscal policy) is certainly going to be limited, since the Italian government has to finance and struggle to reduce what is currently the world's second-largest sovereign debt to GDP ratio. Italy's debt did fall back slightly in 2007 - to 104 percent of GDP from 106.5 percent in 2006 - but it is still huge, and of course 2007 was a remarkably good year, while we may now be about to have a remarkably bad one (or two, or more....). Again interest on the national debt currently runs at some 70 billion euros ($109 billion) a year, or about 1,200 euros for each Italian, and any serious slippage in fiscal "clean up" is going to be closely watch by the financial markets, where, it will be remembered, the difference in yield between Italian 10-year bonds and the benchmark German bunds increased to the most in almost a decade last month. The spread between German and Italian bonds widened to 52 basis points in mid March, the most since October 1998, when it was as by much as 61 basis points. Any repetitions of this incident will surely cost the Italian government dear, since spending programmes - like Italy's pension system that already eats up a full 15 percent of GDP - will almost certainly become more expensive to fund, leading to cuts in other - less protected and less structural - areas.

The deficit itself also fell back last year to 1.9 percent of gross domestic product, its lowest level since 2000. That is about half the 2006 deficit of 3.4 percent and - for the time being - within the EU ceiling of 3 percent. But what this deficit reduction process means is that Italian fiscal policy will also be restrictive, tightening the economy even as it falls back into yet another recession.

Nor will monetary policy be much help - at least in the short term - since Italy's prospects of obtaining cheaper interest rates to aid recovery are currently being frustrated by a European Central Bank anti-inflation policy that has kept borrowing costs at a six-year high of 4 percent even as several important eurozone economies have been slowing, and as the euro has surged - not coincidentally - to ever greater "highs" against the dollar. The single currency has risen by 11 percent over the past six months against the dollar and has hit a record 1.5913 dollars only this week, a development which lead European Union Economic Policy Commissioner Jaoquin Almunia to issue an explicit warning about currency valuations getting out of line with economic fundamentals.

Looking forward Italy's budget deficit is expected by ISAE to rise to 2.7 percent of gross domestic product this year. This is more than the 2.6 percent formerly predicted, (the Finance Ministry currently predict a deficit of 2.4 percent of GDP in 2008, again up from the 2.2 percent originally predicted) though all of this is still within the European Union ceiling of 3 percent. The difficulty is that this position may be subject to slippage, as revenue falls, and - if unemployment were to seriously rise - payments go up. So one of the most important consequences of the current weak growth is that it is likely to put increasing pressure on the budget deficit.

Italian tax receipts were higher than expected in the first quarter of 2008, the Italian Finance Ministry announced last week. Overall tax receipts increased 5.6% to 60.1 billion euro over the quarter, up from 56.9 billion euro in the first quarter of 2007. Overall receipts in March rose 10.1% to 29.9 billion euro from 27.1 billion euro in March 2007. Two-thirds of the increase in tax receipts in the first quarter are due to higher income taxes, according to the ministry's data. However, receipts from value-added tax rose only 0.9% on the year in March, reflecting the weaking climate in both consumer confidence and spending.
"These results are well above the trend projected by all the main macroeconomic variables," the ministry said.

The ministry noted that the 2008 budget forecast a net reduction in tax receipts of around 3 billion euro, so that the excess in the first quarter pointed to the possibility of "extra" income for the state over the course of the year.

Silvio Berlusconi and Walter Veltroni in fact have broadly similar economic programs, offering tax cuts and more public works spending as formulas to revive a stagnant economy. But both have failed to convince either economists or many Italian voters that they can afford to keep their promises.

Italy's ailing economy will limit room to maneuver on policy for its next government, as shown by similarities in the main political programs, a senior credit officer at Moody's Investors Service said on Friday. Alexander Kockerbeck said the targets set by the two main candidates in their programs pointed in the right direction, but the problem would be the next government's ability to achieve them.

Berlusconi pledges tax cuts on everything from income to property and plans to boost spending on costly infrastructure projects such as the world's longest bridge, linking Sicily to the mainland. Veltroni is offering similar tax cuts and wants to boost spending on roads and railways. Their plans are by no means cheap. Berlusconi would need some 63 billion euros to fund his manifesto promises, compared with the 58.3 billion euros for Veltroni, according to economists at Intesa Sanpaolo. To finance their plans, both would need to save money elsewhere and improve tax collection in a country where evasion is estimated to account for a minimum of 15 percent of gross domestic product.

Berlusconi has promised unspecified spending cuts and says he will sell state assets to pay down the debt which he himself accumulated. Veltroni calls for cutting spending by 0.5 percent of gross domestic product during his first year and by 1 percentage point a year after that, without specifying how he would do this.

Apart from the exceptional effort made in 2007, recent Italian governments have not done especially well in cutting state spending 8to put it mildly), which rose substantially during the last Berlusconi administration between 2000 and 2005, and now remains steady at around 40 percent of Italy's GDP. And the situation is a delicate one, since even if both candidates continue Prodi's clampdown on tax dodgers, fiscal revenue will inevitably slow as growth slackens.

Both candidates say they would like to fund special programs, such as increased minimum pension benefits, with the extra income the hope to obtain from clamping down on tax evasion, but they really may be jumping the gun somewhat here, and it will be interesting to see whether they are so imaginative and so enthusiastic when it actually comes to collecting the money in the first place. I would say downside risk for slippage on the fiscal deficit front is strong at this point, and especially if the Berlusconi coalition win the elections.

Silvio Berlusconi, tends to brush aside such concerns, and seems to see the issue as already a "done deal", since he is busy dreaming up ways to spend the extra income, without - it seems to me - taking due account of how the economic slowdown may impact both income and expenditure. "We will use that treasure to abolish this tax that has no reason to exist" he said on the "Matrix" television programende, refering to his "surprise" last minute, rabbit-out-of-the-hat proposal to eliminate a tax on car and motorcycle registration - at a cost of 4 billion euros - a cost which is, of course to be met by tapping the surplus - "that treasure" - always assuming that at the end of the day it exists.

``We hope they would reduce expenditure in public administration and, more importantly in the long term, cut pension spending before contemplating tax cuts,'' S&P's credit analyst Trevor Cullinan said in a telephone interview from London. ``That doesn't look likely.''

The pledge on the part of both candidates to cut Italy's public debt while at the same time easing tax pressure isn't cutting that much ice over at the credit rating agencies however. "I looked at the two programs and they seemed to confirm that margins for maneuver are limited," said Alexander Kockerbeck, senior credit officer at Moody's. Kockerbeck indicated that the stabilization in the level of the country's public debt warranted the retention of the stable outlook for the time being, but but he was quick to add that it was still too early to say whether the trend was under control in the medium term. "The latest positive data on debt and deficit are neutral in terms of their impact on the ratings because we saw them more as cyclical than structural."

To understand just why analysts like Trevor Cullinan and Alexander Kockerbeck may be worried one need look no further than to Silvio Berlusconi's proposed solution to the Alitalia crisis, which involves finding the money to float a rescue, rather than putting the squeeze on the Unions to come to terms with air France. Berlusconi has repeatedly denounced the Air France bid and said he personally would seek an Italian buyer. Veltroni has accused Berlusconi of "interfering" and called on unions and Air France to resume negotiations to save the airline and jobs.

``We cannot give up our flagship carrier,'' Berlusconi said in Rome during a campaign speech. ``I renew my appeal for Italian businessmen'' to join together to buy Alitalia, he said.

And while Alitalia was busy amassing more than 3 billion euros in losses over the past decade, Italy's overall competitiveness was slipping to 46th in the World Economic Forum's 2007-2008 ranking, putting it behind free enterprise stallwarts like Latvia, South Africa and Bahrain. In the 15 country eurozone Italy ranks only above Greece. And much of the slide in both state indebtedness and loss of competitiveness came precisely during Berlusconi's second period as prime minister between 2001 and 2006.

Unicredit economist Marco Valli is widely quoted as saying that he has not tried to do detailed costing on the two programmes because some measures will certainly not be implemented, while the final days of the campaign is seeing a 'crescendo' of promises. However, even without detailed calculations, he argues that it does seem 'possible' that Berlusconi's PDL's plans will breach the EU's 3 percent deficit limit, especially if they do not continue to be so vigourous in the fight against tax evasion (remember, Berlusconi described the methods being used by the outgoing Prodi government as "brutal").

Dresdner Kleinwort have also expressed the view that the new government will run into severe difficulties if it attempts to implement either of the groups' tax cuts. "Indeed, Italy agreed with the EU to reach a budget balance in 2011. With an estimated deficit of 2.4 percent in 2008 and 2.1 percent in 2009, the new government should pursue a tough fiscal policy" it said in a statement.

The prospect of rising debt fuels the risk to Italy's credit rating, ratings companies say. Standard & Poor's and Fitch Ratings slashed Italy's creditworthiness in October 2006, less than six months after the last election. S&P also cut the rating in July 2004, during Berlusconi's tenure. Fitch rates Italy's long-term debt AA-, while S&P gives it A+. Italy's debt is rated 'Aa2' with a stable outlook by Moody's.

And the issue with the ratings agencies is no mean one, as the ECB made clear back in November 2005, when they took the decision not to accept government paper (bonds) in the future from any country which has not maintained at least an A- rating from one or more of the principal debt assesment agencies. So, to end up where we began, rather than Gianni de Michaelis' analogy of the Titanic and the Iceberg, could this recession actually be the occasion that the Italian economy actually lets itself slide so far down the slippery slope that it proves well nigh impossible - in the conetxt of it's sovereign debt dynamics - to claw its way back up again. At this point it is hard to see, but this is not a danger, or a possibility, that any of us should be taking lightly.

Or perhaps Berlusconi has another plan up his sleeve to get Italy out of the mess:

"Ronaldinho only wants Milan", said Silvio Berlusconi. The President of AC Milan, in Savona for an election rally, said: "We are trying our best to bring him to Milan, Ronaldinho said he would not be in any team if not in that of the world champions, that is us. He would come here also because there are so many of his fellow Brazilians and he knows that at Milan we treat everybody very well."

Well I think it only remains for me to express the hope that his plan to keep the former world football champion afloat is not as doomed to failure as his plan to do the same with the national champion airline would seem to be. Or is Berlusconi simply destined to be a dedicated follower of lost causes? Of course, my status as an ardent supporter and enthusiast for Barça FC is in no way clouding my judgement here.