From the folk at 4cast comes this rather unsettling look at the trends within the Italian economy.
We’ve been exceptionally negative on Italy for some time now – see for instance ‘Italy GDP heading negative?’ from the 15th of July where we forecast a sharp downshift pulling the economy into recession over the end of 2011 into 2012, and also the follow up report ‘Periphery negative feedback between money, growth and revenues’ where we suggested that signals were pointing the manufacturing+services PMI dropping to as low as 41.5 from the prevailing near-50 reading and that this could feedback disastrously into negative tax revenues, adding to the cycle of pressure.
The latest PMI readings from Italy suggest these concerns have unfortunately proved entirely founded, with a truly ugly manufacturing survey today. Italy has just posted its sharpest monthly drop ever. The 5 point fall is a 3.5 standard deviation event and just eclipses the (albeit 2 consecutive) drops seen on the back of the Lehmans shock. This puts the current crisis seizure in the same category, albeit not yet quite down to the same absolute levels with the slump over the last 6 months having started from a somewhat higher starting pointed. It is however well on its way to similar territory, with the new orders reading already on a 30 handle (39.4) and the slump in output to the low 40s not enough to avoid involuntary inventory effects with the stocks reading rising.
Make no mistake, it is not hyperbole to say that Italy is crashing. Real narrow money signals continue to get viciously squeezed by a combination of banking stress, economic deterioration and the untimely continued rise in inflation, squeezing the economy on all fronts. Signals are perhaps not quite on the same degree of outright collapse seen in Greece, but they rival Portugal and are in pretty extreme -3.5stdev territory, consistent with a negative shock that is not just at the extreme end of cyclical range into recession territory but getting disorderly.
Putting together a very basic ‘momentum’ model that captures the key cyclical inputs into the economy, the signals are truly alarming for a hugely outsized deceleration in growth from what is already a stagnant Q2 starting point. At face value, the model is suggesting some 3pp to 4.4pp of deceleration in yr/yr GDP by H1 2012, which would take the yr/yr rate down to between -2% and -3.5%. Such a rate of deterioration in growth over that timeframe would rival the 2008 financial crisis crash.
As we noted in our early summer reports, the fear has got to be that this feeds further into the very negative feedback loops that have now become such pressing features since the autumn in feeding into degenerating fiscal assessments, bond sentiment and back into growth outlooks. Current readings, ceteris paribus, point to tax revenue trends heading to more like -10%y/y than positive by end 2012 onwards – note how growth has already peaked and rolled over in line with usual lags.
On IMF projections, Italy’s output gap was supposed to be narrowing to circa -2.5pp of GDP from 3.2pp in 2010. If instead the output gap were to expand to -6pp, then, everything else constant, on very recent best fits, the deficit would be more like -5.5pp to -6.5pp of GDP rather than the narrowing to -2pp from -4pp that was in the prior IMF outlook. Italy has been very lethargic in the ‘austerity race’ to try and gain market confidence with its own political difficulties and could be left chasing shadows and adding to the macro pressure if it is forced into yet more chasing amid a potentially under-estimated degree of growth collapse in coming quarters.