Economic Bulletin No. 46 - 2007

The growing difficulties of two US hedge funds specializing in sub-prime mortgages triggered a crisis in the American mortgage market in July, the repercussions of which were rapidly felt in the international financial, money and stock markets. Risk premiums rose everywhere and lenders grew more cautious; share prices fell and, more important, trading in money markets dried up. These effects were countered by the US Federal Reserve, the European Central Bank and the monetary authorities of other countries, and by injections of liquidity; in addition, the Federal Reserve cut its reference interest rates. These actions served to quell the turmoil.
Despite the greater uncertainty, the crisis does not appear so far to have caused a marked change in expectations of growth in the world economy, although they have now been revised downwards for next year to below 5 per cent by the main forecasters. In the United States, at the epicentre of the crisis, the impact is likely to be greater, with a downwards revision of expected GDP growth to around 2 per cent. The stimulus that emerging countries impart to world growth is likely to remain almost unchanged.
On the basis of the latest economic indicators, the slowdown in economic activity in the euro area in the second quarter was followed by an acceleration in the summer. According to the European Central Bank's most recent forecasts, economic growth in the euro area in 2008 should be close to the potential growth rate.
Following the slowdown in the first quarter, GDP in Italy stagnated in the spring. With the real exchange rate remaining broadly unchanged and in contrast to developments elsewhere in the euro area, Italian exports declined further, affected by the slowdown in economic activity in our main export markets.Household consumption continued to grow at an annual rate of just under 3 per cent in both quarters, benefiting from the recovery in disposable income after the pause of the last two years.
Fixed investment slowed down in line with GDP. During the first half of the year as a whole the growth in domestic demand remained weak, held in check mainly by the negative effect of the change in stocks, which was presumably attributable to gathering uncertainty about the strength of the recovery.
In the second quarter the rise in employment accelerated, partly for statistical reasons due to the recording of non-residents as part of the working population.
The inflation picture remains generally favourable, thanks to limited demand pressures, the appreciation of the euro and moderate overall wage growth. In industry excluding construction the fall in productivity and the rise in per capita labour costs - which was fuelled by the payment of a number of instalments of agreed wage increases - led to a rise of 2.8 per cent in labour costs per unit of output by comparison with the preceding six months.
According to our preliminary estimates, there was a slight acceleration in economic activity in the summer. The main growth estimates now give average rates of below 2 per cent in 2007 and of 1.3-1.5 per cent in 2008.
The exposure of the major Italian banking groups to the US sub-prime mortgage sector appears to be small. The large Italian banks participating in the Eurosystem's Bank Lending Survey report that in the last three months they have had difficulty obtaining funds in the money and bond markets and foresee a moderate tightening of lending conditions in the closing months of the year. Credit risk indicators have fallen slightly and continue to be much lower than in the past.
As in the other leading international financial centres, share prices in Italy have been recovering since the beginning of September, after having fallen from the end of July onwards owing to the crisis in the market in structured credit products.
The public finances have steadily improved since 2006 as a result of a sharp increase in tax revenue, attributable in part to progress in reducing tax evasion and avoidance. The ratio of taxes and social security contributions to GDP will be two percentage points higher in 2007 than in 2005. It will remain stable in 2008 at a relatively high level by international standards. During 2007 the unexpected revenue has mostly been used to fund increased spending. Similar choices have been made for the 2008 budget, which increases the deficit in relation to that on a current programmes basis.
After the considerable improvement of 2006, only modest progress has been made in reducing the budget imbalances. Bringing net borrowing down to under 3 per cent of GDP will pave the way to closing the excessive deficit procedure for Italy, but the measures needed to balance the budget have been put off to the three-year period 2009-11.
In the two years 2007-08 the ratio of primary current expenditure to GDP will remain constant at the highest levels recorded in recent decades.The key issue for the public finances in Italy is curbing primary current expenditure. Initiating a review of public spending, pursuing budget reform, and strengthening the mechanisms for making local authorities accountable are important ways of improving the use of resources in the public sector. Studies by the Ministry for the Economy and Finance show that there is ample scope for making savings without compromising the achievement of the main policy objectives.