Relief for Gentiloni government but expansion may prove difficult to sustain

5 hours ago by: James Politi in Rome

A batch of comforting data has strengthened confidence in Italy’s economic recovery, limiting the drag on the rest of the eurozone and bringing some relief to Paolo Gentiloni’s centre-left government.

Second-quarter gross domestic product figures for Italy will be released next week, with economists expecting growth to have increased by 0.2 per cent, compared to 0.4 per cent in the first quarter.

This would keep the eurozone’s third-largest economy on track for its best performance since the financial crisis: the International Monetary Fund last month upgraded its growth estimate for Italy to 1.3 per cent in 2017, on the back of positive momentum across the currency bloc.

“I’m not sure Italy can be called an overperformer, but it is keeping the pace and benefiting from the improved external environment,” says Loredana Federico, chief Italian economist at UniCredit in Milan.

Other figures have also been encouraging. Activity in Italy’s service sector reached its highest level in a decade in July, according to the IHS/Markit monthly survey published last week.

Meanwhile, unemployment fell to 11.1 per cent in June, down from 11.3 in May and an improvement of 0.7 percentage points compared to where it was in January.

The better economic climate has helped Mr Gentiloni’s government weather a difficult summer because of the migration crisis in the central Mediterranean and will also give him some leeway in crafting a challenging budget in the autumn ahead of a general election due early next year.

The state rescues of three troubled banks, after painstaking negotiations with the EU and the ECB, and an aggressive restructuring at UniCredit, the Milan-based lender, have also eased worries about the financial sector, which has been weighed down by bad loans.

But the fear is that this may be as good as it gets for the Italian economy, and the faster pace of growth experienced in 2017 will not be sustained in the coming years. “As the cycle matures and the euro strengthens, it seems unlikely what we can get much beyond this level,” says Daniele Antonucci, an economist at Morgan Stanley in London.

Marcello Messori, a professor of economics at Luiss University in Rome, adds: “Italy is hooking on to a robust eurozone recovery, but this doesn’t mean that the country’s fragilities have been overcome.”

Domestic consumption has been rising, by 0.5 per cent in the first quarter, but remains sluggish and could be adversely affected by recent increases in inflation. A sustained rebound in investment has yet to take hold: in fact, gross fixed capital formation shrunk in the first three months of the year.

An ambitious economic reform agenda launched by former prime minister Matteo Renzi was continued by Mr Gentiloni — including the parliamentary approval of a new law designed to liberalise key sectors of the economy, from energy to pharmacies, last week — but remains incomplete. Recommended Eurozone recovery is even better than it looks Exiled Spaniards lured home by robust economic recovery Migration opens the door to Italy’s populists

Meanwhile, political risk is ever present: a general election is due in early 2018, in which a strong performance by populist parties could deliver a hung parliament, or even a Eurosceptic government.

This could happen at the same time as the ECB begins tapering its quantitative easing programme, which could bring an unwelcome increase in interest rates.

“Italy is the slumbering risk that could come out in 2018, “ says Bert Colijn, a senior eurozone economist at ING. “Now it doesn’t look like much is going on but markets can change their minds quickly.”

The IMF itself warned last month that “downside risks” in Italy remained “significant”, including “political uncertainties, possible setbacks to the reform process, financial fragilities, and re-evaluation of credit risk during monetary policy normalisation”.