Economic Bulletin No. 45 - 2007

The pace of economic activity in the industrial countries slackened in the first quarter of this year. The slowdown was less pronounced in the euro area than in Japan and the United States, and was probably followed by a recovery in the spring. According to assessments by analysts and businessmen, however, only the United States is likely to see a significant deceleration in GDP over the year as a whole, with the rate of growth falling from 3.3 to 2.1 per cent. The emerging economies, benefiting from continued easy conditions in the financial markets and high raw material prices, are likely to continue to provide impetus to world economic growth, with rates of increase of around 10 per cent in China and India. World trade is forecast to continue to expand at a rapid pace, albeit slightly less strongly than last year; inflation expectations remain subdued everywhere.
In overall terms the economic picture is therefore benign, but it is marred by a number of risks, relating especially to the real and financial outlook for the US economy, such as the crisis at two hedge funds specializing in high-risk segments of the mortgage loan market. In addition, the persistence of a large deficit on the current account of the balance of payments continues to sustain fears of an abrupt fall in the value of the dollar, which could generate turmoil in world financial markets – especially if it were accompanied by sudden shifts in risk perceptions, which at present are low everywhere – and have adverse repercussions on growth, particularly in emerging countries.
In the euro area, following the slowdown in the first quarter in common with the other industrial economies, it is estimated that economic activity is growing at rates in line with estimated potential, which is put at between 2 and 2.5 per cent. Private analysts forecast growth of 2.7 per cent this year, in line with projections by the Eurosystem economists.
In an environment of rapid growth, the gradual return to a less accommodating monetary policy stance helped to anchor expectations of euro-area consumer price inflation at 2 per cent. In May the twelve-month increase in the harmonized index was unchanged at 1.9 per cent; according to preliminary estimates it remained at the same level in June.
The exceptional acceleration in the Italian economy in the latter part of 2006 was followed by a particularly abrupt slowdown in the first quarter of this year, with growth falling from 4.4 to 1.2 per cent on an annual basis. The main contributory factor was a fall in exports due to a pause in growth in Germany in connection with the introduction of new VAT rates. The cautious attitude of firms, which preferred to meet demand by drawing heavily on stocks, caused a sharp fall in industrial production. The slowdown in GDP growth was accompanied by a fall in employment.
The available indicators suggest that GDP growth was running at an annual rate of more than 1.5 per cent in the spring, thanks mainly to the recovery in exports.
According to national accounts data, the cooling of activity in the first quarter did not halt the rise in productivity in the economy as a whole. The profit margins of non-financial firms, which have increased for three successive quarters, continued to widen; self-financing rose from the low levels of 2006. Investment growth weakened, but firms’ borrowing requirement remained high. Bank borrowing increased by 10 per cent; by contrast bond redemptions slightly exceeded new issues. In the second quarter, with the cost of bank borrowing rising only slightly, the recovery in activity signalled by the economic indicators is likely to have given fresh impetus to demand for capital goods.
In the first three months of the year the growth in household expenditure accelerated unexpectedly to 2.8 per cent on an annual basis, fuelled by purchases of durable goods and services. One factor was the recovery in disposable income, which is estimated to have risen by around 0.5 per cent in real terms compared with the end of 2006. Leaving aside the effect of specific factors, such as incentives to scrap motor vehicles, the qualitative and quantitative indicators signal the persistence of a degree of caution in spending decisions. Bank borrowing slowed down slightly.
Consumer price inflation fell to a twelve-month rate of 1.6 per cent in the second quarter, reflecting stable expectations, moderation in domestic costs and an easing of external price pressures.
On the supposition that the expansion in the world economy will continue for the next two years and that the public finances will evolve in line with the estimates set out in the recent Economic and Financial Planning Document (EFPD), we expect Italian GDP to grow by 2 per cent this year and slightly less in 2008 (1.7 per cent); this latter rate is broadly in line with the estimated growth in potential output. The stimulus from exports is likely to be joined this year by a boost from consumption, thanks to the recovery in disposable income, which was squeezed last year by the sharp increase in taxation. Investment continues to benefit from the cyclical upturn, but its growth is likely to be curbed in 2008 by the increase in real interest rates and less favourable conditions in the real estate market. Overall, final national demand is expected to grow at an annual rate of more than 1.5 per cent over the two-year period.
Exports should benefit from the strong growth in world trade, rising at rates of between 3 and 4 per cent. They are being depressed this year by the lagged effects of the loss of competitiveness due to the appreciation of the euro and the rapid increase in our export prices. Looking to the future, we assume that continuation of the restructuring of Italian firms that is now under way will halt the deterioration in our competitiveness and gradually reduce the disparity between the growth in Italian exports and the growth in world demand.
On the basis of provisional and partly estimated data, the general government borrowing requirement net of asset disposals amounted to €48.5 billion in the first five months of the year, about €10 billion less than in the corresponding period of 2006. The EFPD sets a new target of 2.5 per cent of GDP for the 2007 budget deficit; this takes account of a figure of 2.1 per cent on a current programmes basis (0.2 points less than the estimate given in March) and the higher expenditure announced by the Government by decree at the time of publication of the EFPD and in the mid-year budget revision. The Government plans a modest reduction in the deficit in 2008, to 2.2 per cent of GDP, and sterner action in subsequent years, with the aim of balancing the budget in 2011. In his Testimony to Parliament on the Economic and Financial Planning Document for the years 2008-2011, delivered on 16 July 2007, the Governor of the Bank of Italy examines the situation and prospects for the public finances.