Italy
• Subdued recovery, absent improvements in the banking sector and a weak labor market lead to a bleak growth outlook.
• Italian credit spread rising as financial markets anticipated a “No”-vote in December referendum
The Italian economy has an anaemic recovery that has continuously been lagging behind the recovery of the entire Euro Area. In Q3 2016, the Italian GDP grew by 0.3 % (q/q) and 0.9 % in annual terms. Q3 GDP details are not available at this stage but the domestic economy presumably remained weak. In the previous quarter, private consumption had stagnated (0 % q/q, 1.2 % y/y-change) and fixed investment had declined in quarterly terms (-0.3 %). Real net exports have been declining amid weak export growth. Last year, real GDP had expanded by 0.6 %. The underlying trend of the economy is due to remain weak over the coming quarters and GDP growth below 1 % in 2017. Tensions in the banking sector may continue to effect growth negatively via the sentiment channel and weak investment. Escalating political uncertainty following the constitutional referendum in December may further put a drag on economic sentiment, investment and growth. In addition, it may limit the incremental likelihood of further reform to lift long-term growth prospects.
According to numerous surveys (PMI, INSTAT, EC), economic sentiment deteriorated during 2016 after a rebound last year. Policy uncertainty (constitutional referendum in December) and the banking sector recapitalisation likely contribute to worsening sentiment as well as the weak economy.
While the Euro Area-wide credit market displays signs of a recovery (household and company loans returning to expansion), the Italian credit sector remained in contraction.Total loans to non-financial corporates continued decreasing (-2.4 % y/y in September) as well as household lending (-3.9 %). Results from the bank lending (October) survey indicate that, while overall lending conditions have been improving since 2011/12, bank’s credit standards for loans to enterprises and loans for house purchase remained unchanged in Q3 2016, while credit standards for consumer loans eased marginally. Demand for enterprise loans has deteriorated in Q3, while demand for household mortgage loans and consumer credit increased in Q3 2016. The dysfunctional credit channel will likely remain a drag on growth in the coming quarters.
The picture is also bleak in the labor market. The unemployment rate had reached its peak at 13.1 % in 2014. Since more than a year, it has mostly been stagnating at an elevated rate and was recorded at 11.7 % in September. At the same time, the unemployment rate has been falling in Spain, Portugal and Greece. Total employment has slowly been expanding since 2014 and increased by 1.4 % (y/y) on average in the first half of 2016. Hourly wages recorded subdued growth recently (0.6 % y/y in September).
The referendum in December
On 4th of December a referendum will be held about a reform of the Italian constitution. The reform includes a reduction in the number of seats in the upper chamber (the Senate) from 320 to 100 and changes in its functions and powers including the abolition on confidence votes upon the appointment of a new government. A new electoral law that came into force in July (‘Italicum’) guarantees a majority in the lower house to the winning party in the national elections. The possibility of an opposition majority in the upper house has previously been increasing political instability and putting a gridlock on political decision making. Basically, the changes intend to make it easier for governments to pass new laws by transforming the lower house into the primary legislative body.
So far, polls seem to suggest a majority vote against the proposed constitutional changes. The critical question is about the political and economic consequences of a decision against the changes and the short- and medium-term reaction in financial markets. The credit spread versus 10-year German government bonds has spiked recently and reached 180 basis points last week (Figure 4); the highest BTP spread since late-2014. The spread had peaked around 550 basis points the last time in 2011 at the height of the Euro crisis.
Politically, there is some chance PM Renzi is going to resign in case of a “No”-vote thereby increasing political uncertainty. Given how most recent referendum polls came out, this seems to be the scenario to which financial investors attach a high probability. The next general elections would be set for 2018, so snap elections would be one possibility although with low probability. Alternatively, the appointment of a new government backed by a different majority in the lower house has some chance as early elections would mostly help the oppositional Five Star Movement (‘M5 S’).
As a matter of fact, political uncertainty is set to remain after a “No”-vote in December and this is also the scenario that investors are currently pricing. In the absence of a deeper political crisis (or chaos), the anticipation of the event could limit the downside upon impact versus current BTP spread levels. Another risk would arise from negative credit rating actions. As said, the economic recovery will remain weak and mostly due to the resolution of problems in the banking sector, but not directly linked to the voting outcome. Negative repercussions from the referendum on already weak confidence and investment would further dampen the recovery. Although the upside on deeper reform following an (unexpected) “Yes”-vote is likely limited, further progress would likely be blocked until the next general elections in 2018.