The global economy is slowing - Sovereign debt strains in the euro area and the persistent uncertainty over the consolidation of the public finances in the United States are affecting the growth prospects of the advanced economies. In Japan, recovery in the third quarter gave way to a weakening as the year closed. There are signs that world trade slowed in the fourth quarter.
The sovereign debt strains in the euro area have become systemic ... Sovereign debt strains in the euro area worsened and spread, becoming systemic. In many countries government securities' prices suffered as a result of uncertainty over crisis management mechanisms at European and intergovernmental level, despite the important corrections to public finances made by national governments; the uncertainty was heightened by deteriorating growth prospects. Investors' risk aversion increased, as did their preference for instruments considered safe, such as US and German government securities. On 13 January the rating agency Standard & Poor's downgraded the sovereign debt of nine euro-area countries, including France, Italy and Spain.
... although they are easing on shorter maturities - The spread between the yields on Italian and German ten-year government securities, which reached 550 basis points in November, the highest figure since the introduction of the euro, narrowed significantly at the start of December following the announcement of new, incisive measures to correct the public finances; it began to increase again as concerns that the crisis was systemic mounted. However, the risk premiums on government securities with shorter maturities have contracted sharply in recent weeks, following the launch of the EC B's three-year refinancing operations.
Economic activity in the euro area weakens in the fourth quarter; inflation is easing - In the last part of 2011 the economic situation of the euro area weakened. The €-coin indicator which estimates underlying quarterly GDP growth in the area, turned negative from last October. Growth expectations for 2012 were also revised downwards. On the positive side, inflationary pressures abated, benefitting from the reduction in pressure on input costs.
The Eurosystem eases monetary conditions and supports lending to the economy - The EC B Governing Council lowered official interest rates on two occasions, bringing the rate on main refinancing operations down to 1 per cent; it introduced important new measures to support banks' lending to households and firms, which has been hampered by growing difficulties in funding and the segmentation of the interbank markets. The first refinancing operation at 36 months with full allotment of the sums requested took place on 21 December. Following this operation, the increased liquidity in the banking system and the reduction of concerns over banks' ability to raise funds were reflected in a contraction in the risk premiums implicit in the interbank rates and an improvement in the spreads on banks' credit default swaps.
In Italy economic activity is influenced by the domestic and international situation - In the third quarter of 2011, Italy's GDP declined by 0.2 per cent compared with the second, and according to our estimates contracted in the fourth quarter as well. The weakness of domestic demand is confirmed by the latest data and by business surveys. GDP growth has been affected by an increase in the cost of borrowing, as a result of the worsening sovereign debt crisis, and by the slowdown in world trade, which has nevertheless continued to contribute positively to economic activity. Domestic demand was also adversely affected by the measures to correct the public finances, which were nevertheless essential to avoid even more severe consequences for economic activity and financial stability. Firms' competitiveness improved slightly thanks to the depreciation of the euro.
Labour market recovery comes to a halt - The recovery in employment that began in the last quarter of 2010 came to a halt in the closing months of 2011; in October and November there was a reduction in the number of persons in work and an upturn in the unemployment rate, which reached 30.1 per cent among young people. Even if recourse to wage supplementation continued to decline, firms' expectations of their employment levels were more pessimistic.
Inflationary pressures ease, despite price rises induced by indirect taxation - Inflationary pressures are waning in a context of cost moderation and slack demand. In the closing months of 2011 an increase in indirect tax rates caused a rise in consumer prices; another rise could result from the higher excise tax on fuels enacted at the start of this year in some regions and rises in some regulated prices.
The Eurosystem is acting to counter the strains on bank funding, which could impinge on the credit supply - In recent months the tensions in the government securities market and the resulting financial market uncertainty have affected banks' funding, especially in the wholesale segment. There are signs that these difficulties are being transmitted to the supply of credit to the economy. The problem should be mitigated by the possibility of ample recourse by banks to the new Eurosystem refinancing operations. In the meantime, Italian banks have strengthened their capital bases further. Following the indications of the European authorities, the main banking groups are required to submit plans for additional increases in their capital base, which must not result in a reduction of lending to the economy.
The state sector borrowing requirement and public sector net borrowing decline - The state sector borrowing requirement came down from 4.3 per cent of GDP in 2010 to 3.9 per cent last year. The final figure for net borrowing should be near the Government's early-December estimate of 3.8 per cent of GDP, significantly lower than the 4.6 per cent registered in 2010. The ratio of debt to GDP, which was 118.4 per cent in 2010, appears to have risen to about 120 per cent, a smaller increase than the estimated average for the other euro-area countries.
The Government passes a third budget correction in December - The drastic aggravation of the European sovereign debt crisis necessitated a further adjustment in December of the public accounts for the three years from 2012 through 2014, the third correction since July. Enacted by Parliament on 22 December, the package is designed to fulfil Italy's European commitment to balance the budget in 2013.
The structural adjustment amounts to about 5 percentage points of GDP - According to official estimates, the December measures will reduce net borrowing by more than €20 billion (1.3 percentage points of GDP) in each of the three years from 2012 through 2014. They also raise resources (some €15 billion in 2013) for measures to stimulate growth and to diminish the part of the deficit reduction left to the implementation of tax and welfare reform. The adjustment depends largely on revenue increases, but expenditure savings are increasing over the three years. The measures on pensions will produce their full effects over an extended period of time. The combined effect of the three sets of measures enacted from July to December is a structural correction estimated at €80 billion, which is expected to yield a primary surplus of about 5 per cent of GDP in 2013 according to the macroeconomic forecasting scenarios set out in this Bulletin.
The uncertainty over the outlook for growth is exceptionally pronounced - The worsening of the sovereign debt crisis and the slowdown in world trade have resulted in a deterioration of growth prospects in Italy and the euro area. For Italy, the plausible scenarios vary considerably, depending on developments in the sovereign debt crisis and its repercussions on banks' lending capacity.
A normalization of financial market conditions is crucial - Assuming that for the next two years the interest rates on government securities are those indicated by the yield curve at the start of January, GDP is forecast to contract by an average of 1.5 per cent this year. Economic activity would not start to expand again until next year. There is the risk that if deteriorating expectations entail a further tightening of sovereign debt and credit market conditions the downturn will be more marked. On the more favourable assumption that the Government's fiscal consolidation package together with the crisis-response measures agreed at European level succeed in at least partly restoring investors' confidence, thereby reducing financing costs for all economic agents (public sector, banks, firms and households), the Italian economy could recover more rapidly. A return of the BTP-Bund spread to around last summer's levels would imply an average contraction in economic activity in 2012 not greatly different from the first scenario, but with activity levels stabilizing in the second half and a quicker return to growth in 2013.
Structural measures to strengthen the economy's capacity for growth could have effects even in the short term - Now that the package of measures to adjust the public finances has been finalized, the priority is to create favourable conditions to revive the Italian economy. The structural measures for economic growth now being finalized, which reinforce those introduced last summer, have not been factored into the forecasting scenarios. But if well designed and promptly implemented, these measures, by stimulating potential output growth, could affect market expectations and the spending decisions of households and firms positively, with benefits not only in the longer run but also for the performance of the economy this year and next.
It is urgent that the European instruments for financial stability become operational - Ambitious policies to restore confidence and normalize market conditions are necessary at national and European level. It is crucial to implement all the elements of the EU economic governance framework that recently came into force. At the same time, it is of vital importance that the strengthened European tools for financial stability, such as the EFSF and the ESM, rapidly be made operational, enhancing their effectiveness and quickly exploiting their potential.
