Europe waits for Italy

Back in July 2012 I posted on the potential for renewed European economic instability due to the 2013 Italian election outcome. The election is occurring as I type and I must admit that the parallels to last year’s Greek election are quite easy to draw, and it isn’t just the country’s economic situation that makes that so.

Much like Greece’ Alexis Tsiparis, Italy’s 5 star movement leader Beppe Grillo is running a campaign based on renegotiating the country’s relationship with the rest of Europe, including the scrapping of austerity, while the centre-left Democratic party of Pier Luigi Bersani is doing its best to be Italy’s version of Greece’s New Democracy by being both the favourite and attempting to hold the current policy line.

In the most recent polls Bersani holds around 35% of the vote but in order to form a government he needs a larger percentage and he is expected to struggle to capture the Senate outright. Silvio Berlusconi is also in the picture, but has been consistently behind Bersani in the polls. Obviously a greater result would see Italy’s political risks grow rapidly.

Mario Monti, the technocrat turned politician, is expected to do quite poorly in the election, as he is seen responsible for a rise in unemployment to a record 11.2% during his 15 month term while the economy shrank by 0.9% in Q4. However, if his party can hold onto 8% of the vote then a coalition party opportunity is the most likely possibility.

As I said in the previous post, the question is whether Italy will come out of the elections with a government with the strength to appease the rest of Europe, yet wear the burden of the political fall-out to defend those policies domestically, while somehow finding economic growth. It is a huge ask, and even if the election outcome is one of the less politically risky outcomes the threat of further instability cannot be ruled out over 2013.

Over the weekend Cyprus also held an election for a new president who is expected to steer the country through it’s massive bailout request and new protests came to Spain as yet another tax scandal erupted, this time involving the King’s son-in-law.

In the meantime the European Commission released their latest economic forecast for the zone, with yet another downgrade hidden behind optimism:

While financial market conditions in the EU have improved substantially since last summer, economic activity was disappointing in the second half of 2012. However, leading indicators suggest that GDP in the EU is now bottoming out and we expect economic activity to gradually accelerate. The pick-up in growth will initially be driven by increasing external demand. Domestic investment and consumption are projected to recover later in the year, and by 2014 domestic demand is expected to take over as the main driver of strengthening GDP growth.

The weakness of economic activity towards the end of 2012 implies a low starting point for the current year. Combined with a more gradual return of growth than earlier expected, this leads to a projection of low annual GDP growth in 2013 of 0.1% in the EU and a contraction of -0.3% in the euro area. Quarterly GDP developments are somewhat more dynamic than the annual figures suggest, and GDP in the fourth quarter of 2013 is forecast to be 1.0% above the level reached in the last quarter of 2012 in the EU, and 0.7% in the euro area.

The contrast between the improved financial market situation and the muted macroeconomic prospects for 2013 is to a large extent due to the balance-sheet adjustment process, which continues to weigh on short-term growth. As this process advances, it will also strengthen the basis for growth in 2014, which is projected at 1.6% in the EU and 1.4% in the euro area.

Olli Rehn, Commission Vice-President for Economic and Monetary Affairs and the Euro said: “The ongoing rebalancing of the European economy is continuing to weigh on growth in the short term. The current situation can be summarised like this: we have disappointing hard data from the end of last year, some more encouraging soft data in the recent past, and growing investor confidence in the future. The decisive policy action undertaken recently is paving the way for a return to recovery. We must stay the course of reform and avoid any loss of momentum, which could undermine the turnaround in confidence that is underway, delaying the needed upswing in growth and job creation.”

A gradual pickup of consumption and investment expected

Important policy measures adopted since last summer have shifted markets’ assessment of the viability of EMU and the fiscal sustainability of its Member States.

A combination of cyclical weakness, uncertainty and the protracted adjustment of balance sheets and redeployment of resources across the economy – typical of the aftermath of a deep financial crisis – is currently holding back domestic consumption and investment. The return of confidence among households and businesses should however reduce the negative impact of these factors. As the easing of financial market tensions is expected to feed through into better lending conditions, this should open the way for a gradual return of consumption and investment growth in the course of 2013.

The current weakness in economic activity is expected to lead to an increase in unemployment this year to 11.1% in the EU and 12.2% in the euro area.

As the impact of higher energy prices on inflation is expected to wane, consumer-price inflation in the EU is forecast to decrease gradually in the course of 2013 and to stabilise at around 1.7% in the EU and 1.5% in the euro area next year.

So again we see a downgrade of existing predictions. The data is poor now, and unemployment is expected to worsen, but the confidence fairy is expected to make her return very soon now and when he does all will become better (there has been some hint of the revival in the ZEW and IFO surveys). However, the ECB’s banking surveys have shown for well over two years that the lack of borrowing has been a demand not a supply issue. So, much like other false dawns of the last 5 years, I expect these predictions to be overly optimistic. Not that this is unexpected, the Commission has been at the forefront of the current economic policies of Europe so anything but positivity would be tantamount to an admission of failure, even if 2013 is now predicted to be yet another year of contraction.

The latest data out of Europe, specifically the PMI data, shows that France is becoming further entwined in the downfall of the periphery while Germany continues to be the only real area of sizeable economic strength in the area. As we saw in Moody’s downgrade of the UK the lack of overall growth continues to leak out of Europe. The problem is that this is just more evidence that the current policies are forcing one-sided retrenchment on debtor economies and the much needed re-balancing is failing to occur because creditor nations have not introduced their own policies to compensate.

So as I said back in January:

As I’ve been covering over the last few months the downturn is beginning to creep into other AAA rated countries with The Netherlands and France looking particularly vulnerable as we enter 2013. On top of that, all of the original PIIGS, with the probable exclusion of Ireland, still have the potential to miss their existing fiscal targets and that is even after the latest Greek write-downs.

This year we will see renewed fiscal tightening in Spain, Portugal, Italy and France which is again likely to dampen growth. We also have major elections in both Italy and Germany which have the potential to change the political landscape, while the on-going question of what to do about Cyprus and further increases in unemployment creates the potential for “black cygnet” events.

Nothing has changed since.


  1. Good to see you back DE. An interesting podcast on BBC World over the weekend on Italy, the election and economic travails. Will try and source later.