Activity picks up pace in the US but the global outlook is still clouded
Economic activity has accelerated sharply in the United States, with growth exceeding expectations. However, the prospects for the world economy remain uncertain in the short and medium term, owing to persistent weakness in the euro area and Japan, the protraction of the slowdown in China, and the brusque downturn in Russia. The drastic fall in oil prices, due both to expanding supply and weakening demand, may help to sustain growth, but at the same time it is not without risks for financial stability in the oil exporting countries.
Market volatility reflects political instability in Greece
Volatility has increased in the euro-area financial markets since the calling of a general election in Greece for the end of January: the possible repercussions of a change in Greece’s economic policy orientation and public debt management have stoked concern about the cohesion of the euro area. Interest rates on three-year Greek government securities have topped 15 per cent. While European stock markets have fallen, risk premiums on the peripheral countries’ government securities have been broadly stable, presumably owing to mounting expectations of further monetary policy measures on the part of the ECB. The downgrading of Italy’s sovereign debt by Standard & Poor’s in December, motivated by the uncertain prospects for growth, had no significant effect on government securities yields.
To counter deflation, the ECB Governing Council intends to expand the Eurosystem’s balance sheet
Consumer prices in the euro area declined in December. The drop in oil prices will sustain consumption but could heighten the risks that expectations of persistently low inflation will take root and that real interest rates will rise, aggravating the burden on indebted sectors. To counter these risks and bring inflation expectations back up to the levels consistent with price stability, the ECB Governing Council has reaffirmed its intention to expand the Eurosystem’s balance sheet until it is near the size recorded in March 2012. Recourse to targeted longer-term refinancing operations, which has fallen short of the initial expectations, could prove insufficient. The Council, which will assess the situation again at the end of January, is prepared to alter the size, pace and composition of its policy measures.
In Italy consumption grows but investment is at a standstill
Consumption has been growing modestly in Italy since the summer of 2013, mirroring disposable income, which has been sustained by government measures. Its contribution to the growth of the economy has been offset by the decline in investment, which is being held back by abundant idle capacity, pronounced uncertainty over the outlook for demand and the problems of the construction industry. The data available indicate that in the fourth quarter GDP again contracted slightly.
Employment expands in the third quarter but contracts in October and November
The number of persons employed in Italy grew, if marginally, in the third quarter. After three quarters of substantial stagnation, the number of hours worked increased both in industry excluding construction and in private services. Nevertheless the unemployment rate rose, reflecting an increase in the participation rate. The employment recovery remains fragile, however, as is shown by the preliminary data for October and November: firms’ expectations for labour demand in the early months of 2015 continue to be negative.
Inflation is affected by weak demand and falling oil prices
Price dynamics are still weak. In December consumer prices fell by 0.2 per cent in the euro area and 0.1 per cent in Italy, and given declining energy prices the downward trend could continue. The latest survey by the Bank of Italy and Il Sole 24 Ore indicates that firms expect to keep their selling prices substantially unchanged in 2015.
Credit conditions are improving gradually
According to the latest surveys, credit conditions for firms have improved, but they remain tighter for small businesses. The average interest rates on new loans have come gradually down but are still about 30 basis points above the euro-area average for both firms and households. Demand factors connected with the weakness of investment, combined with perceptions of high credit risk for some categories of firm, are still impeding credit growth.
The outlook for the next two years depends on the strength of the investment recovery …
We project modest growth of the Italian economy this year and stronger growth in 2016: around 0.4 and 1.2 per cent in the two years in our central scenario. These projections are subject to considerable uncertainty. The crucial factor will be the strength of the upturn in investment, which could be bolstered by a rapid improvement in the demand outlook and financing conditions, notwithstanding substantial spare production capacity. Economic activity would grow more if oil prices stayed at the levels of the last few days.
… and on economic policies
In addition to benefiting from falling oil prices and the gradual acceleration of world trade, economic activity is expected to be sustained by the expansive stance of monetary policy, reflected among other things in the depreciation of the euro, and by the measures enacted in the Stability Law to reduce the tax wedge. Risks for economic activity could derive from a rekindling of international financial market tensions due to the deterioration of the political situation in Greece and the crisis in Russia, as well as from the cyclical slowdown in the emerging economies. The risk that inflation could remain too low for too long stems from the persistence of ample idle capacity, whose impact on price dynamics appears to have increased in recent years, and the possibility of a further worsening of expectations.
The projections are sensitive to the assumptions on budget policy
Fiscal consolidation remains an essential objective for Italy. Our macroeconomic scenario incorporates the effects of the 2015 Stability Law, with which the Government reaffirmed its commitment to adjusting the public finances while adapting the pace of the adjustment to cyclical economic conditions. This will help to avoid prolonging the recession further, which would have an adverse effect on the debt-to-GDP ratio over the next two years.
Aggressive monetary policy measures can counter the risk of deflation
Aggressive monetary support measures can help to combat the downward pressure on prices and the weakness of economic activity. We estimate that an expansion of the Eurosystem’s balance sheet resulting in a 50 basis point decrease in the interest rate on long-term government securities and a 5 per cent depreciation of the euro would raise the level of GDP by about half a percentage point in 2015-16 in Italy and the euro area; inflation would be between 0.2 and 0.3 points higher each year. Factoring in the possible impact of such measures on business and household confidence and inflation expectations, the effects would be greater.
