Economic Bulletin No. 47 - 2008

The global economy has been shaken by the subprime mortgage crisis and rising raw material prices - Worldwide the macro-economic picture continues to be dominated by the crisis in the US subprime mortgage market that began last summer and its implications for financial markets and economic growth. Tensions on markets have increased volatility as operators react to a series of reports on the losses of several intermediaries, the downturn in the American property market, and economic growth in the major areas. A second important feature of the global economy has been the sharp increase in raw material prices for energy and food products, caused by a multiplicity of factors including strong demand from emerging economies.

The overall outlook becomes more uncertain - These developments have led to a downward revision of last autumn's growth expectations while inflation forecasts have been revised upwards. Dimmer prospects for the year ahead have concerned the United States in particular; the Federal Reserve responded by cutting official interest rates on three successive occasions, by a total of one percentage point, to 4.25 per cent. Market operators expect a further cut to be approved at the upcoming meeting of the Federal Open Market Committee. Growth in the euro area in 2007 exceeded potential on an annual basis but declined in the last quarter. According to the Eurosystem's staff projections, published last December, growth in 2008 should be barely in line with the potential rate; inflation is expected to remain at over 2 per cent for most of the year. In this climate the Governing Council of the ECB has kept official rates unchanged at 4.0 per cent. In contrast to the present difficulties in the main industrialized countries, emerging economies have continued to grow at a strong pace and look set to sustain the global economy again in 2008.

Italy's economy also slowed at end-2007 - Following a modest upturn in the third quarter, industrial output in Italy apparently fell in the last three months of the year. The decline in growth is confirmed by the survey qualitative indicators, including those relating to the service sector. In the first nine months of 2007 productivity growth in the industrial sector remained limited; price competitiveness suffered further setbacks. Unit labour costs grew more than in the same period in 2006. Bank loans proved able to satisfy the rising borrowing requirements of businesses. The increase in bank debt, which was particularly marked in the case of medium and large enterprises, may have reflected, in more recent months, the worsening bond market conditions, which have precipitated a fall in net bond issuance. Corporate profitability remained stable.

Consumer spending has shored up domestic demand but is now slowing - It is estimated that after strong growth in the first half of 2007, consumption all but stagnated in the second. In recent months spending is likely to have been adversely affected by rising prices due to the higher cost of raw materials. Fixed investments slowed in line with GDP. Foreign demand has been increasingly affected by the strong euro and slowing growth in major market outlets.
Data on employment for the same period in 2007 are positive: more people were in work and the rate of unemployment fell. In the third quarter the participation rate returned to growth, including in the South of Italy; the number of women participating in the labour market rose while the decline in the participation rate of young people was halted.
As elsewhere in the euro area, consumer price dynamics were unsettled by the rising prices of raw materials, which according to the harmonized consumer price index increased by an average of 2 per cent in 2007.

The borrowing requirement has dropped sharply; the debt to GDP ratio is falling again - The data on public finances point to a significant im-provement in closing balances compared with 2006. The state sector borrowing requirement fell to its lowest level since 2000. Net borrowing and debt are expected to come in below Government estimates of end-September (equal to 2.4 and 105 per cent of GDP respectively), which were already lower than the objectives established a year earlier in the 2007 budget package (2.8 and 106.9 per cent). In the first nine months of 2007 the ratio of taxes and social security contributions to GDP increased with respect to the same period in 2006; the ratio of primary current expenditure to GDP declined; finally, capital expenditure remained substantially unchanged in nominal terms, not counting the estimate of the refunds to be paid following the European Court of Justice VAT ruling in 2006.

Forecasts for Italy have also been adversely affectedby the global shocks - Since the publication of our forecasts for the Italian economy in the July Economic Bulletin, the world economic outlook has deteriorated sharply as a result of the developments described above. It is now expected that Italy's economy will expand at an annual rate of around 1 per cent in the two years 2008-09, below the potential growth rate. The downward revision for the current year with respect to last July, equal to 0.7 percentage points, is attributable essentially to the deteriorating external situation, whose effects began to be felt in the fourth quarter. Similar revisions are being made to the forecasts for the other euro-area economies.
Estimates also predict that consumption growth will not exceed around 1 per cent both in 2008 and 2009; investments are expected to experience a sharp slowdown, above all in the housing sector. The contribution of foreign trade to GDP, almost nil in 2007, is forecast to dip just below zero in 2008. Exports are likely to expand at a slower pace than international trade, reflecting the loss of price competitiveness of Italian goods, which is forecast to continue in 2008 and 2009.
Consumer inflation is expected to average just over 2.5 per cent in 2008, dropping to around 2 per cent towards the end of the year and averaging that level in 2009. This scenario reflects above all the price increases in world crude oil and agricultural goods, and is only partly due to rising domestic costs. Finally, unit labour costs are expected to rise by over 3 per cent in the private sector, owing in part to the cyclical slowdown in productivity.
This forecast is subject to significant uncertainty, reflecting the uncertain world scenario. There is a risk that the cyclical slowdown in the United States and the other advanced economies will be sharper than assumed here. The rises in raw material prices could be more sustained than market prices now imply. On the other hand, there is still the possibility that increasing numbers of Italian firms may acquire the capability to work for structural competitive advantage based on technology and innovation.

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