Global economic activity slowed over the summer and growth estimates in the leading economies have been revised downwards for next year. The global economic cycle remains heavily influenced by high inflation, the energy and food supply difficulties caused by the continuing conflict in Ukraine, the latter exacerbated by drought conditions, as well as by the slowdown in the Chinese economy. The central banks of several countries are continuing to normalize their monetary policies in order to counter inflationary pressures.
Conditions on the global financial markets have worsened since the spring. At a time when economic activity is gradually losing momentum and long- term interest rates are rising rapidly, there have been episodes of high volatility and deteriorating liquidity in the main advanced economies, on government bond markets too. The tensions in the commodities segment, ongoing for nearly one year now, have led to difficulties for some financial intermediaries and several energy companies operating in the commodity derivatives market. Tensions could still emerge, even though some countries have intervened to limit critical issues.
The risks to financial stability have increased in Italy too, although the banking system, households and firms are sounder overall than during past episodes of turmoil. As in other euro-area countries, the increase in risks is mainly due to the persisting geopolitical instability, rising energy commodity prices, inflationary pressures and worsening growth prospects, revised downwards for 2023.
Public finance conditions benefited from the economic recovery in 2021 and in the first nine months of 2022. To consolidate the reduction in the ratio of net borrowing and public debt to GDP, keeping public spending under control and achieving a stable increase in growth potential will be key, including by leveraging the effective and timely implementation of the National Recovery and Resilience Plan (NRRP). Following a significant widening over the last few months, the yield spread between Italian and German government securities has returned to the levels recorded last spring.
The real estate market continues to recover. Prices in the residential sector have risen faster than in 2021, but less so than in other euro-area countries and compared with the simultaneous rise in inflation. The decline in prices has slowed in the non-residential sector.
The risks to financial stability linked to the situation for households remain low. After a positive trend in disposable income in the first part of the year, the outlook has worsened in the second half because of persistently high inflation. Indebtedness nevertheless remains stable and low by international standards. The average cost of outstanding loans has risen slightly, but remains at very low levels. The effects of the withdrawal of monetary policy accommodation are being passed through to the cost of new loans, although debt servicing costs are not exposed to significant risks of a rise.
The financial condition of firms is being affected by the slowdown in economic activity, rising energy prices and higher interest rates. However, debt servicing capacity remains high. Indebtedness rose during the summer, especially that of large firms, while lending to smaller firms declined. In the second half of the year, deteriorating market conditions have adversely affected the cost of bond funding.
Banks are in solid shape overall, but weakening macroeconomic conditions, inflationary pressures and some of the effects of rising interest rates could impact their balance sheets. In the third quarter, asset quality continued to be good and the new non-performing loan ratio remained at historically low levels. Profitability improved in the first half of the year, mainly due to the increase in net interest income. Capitalization is still higher than that observed prior to the pandemic, although it declined as a result both of share buybacks and of the fall in the market value of portfolio securities. Going forward, the higher cost of debt could affect the capacity of households and firms to repay their loans, with potential repercussions for credit quality. There may also be upward pressures on the cost of funding, partly as a result of the need to replace the funds acquired through the Eurosystem's third targeted longer-term refinancing operations (TLTRO III) and to issue instruments that satisfy the minimum requirement for own funds and eligible liabilities (MREL). However, the level of system capitalization should still be adequate overall, even if the macroeconomic situation proves to be worse than expected, matching the adverse scenario published in last October's Economic Bulletin.
The capitalization of the insurance sector has recorded a moderate decline, although it remains high. In the first half of 2022, profitability was negative in the life sector due to losses on portfolio securities. The sector's liquidity position is stable and high by European standards. In the life sector, however, there is a gradual increase in the ratio of surrenders to premium income.
The positive trend in net subscriptions of Italian investment funds has continued, with a shift in flows from bond funds to equity and money market funds. The degree of liquidity improved further and is still high by historical standards. The risks facing the sector remain modest.