Credit Impulse Update: Italy
Head of Macro Analysis
Summary: We feel that markets are over-invested in the "Italian budget blowout" narrative, but our credit impulse indicator still confirms a negative view on the country's economy.
This indicator tends to lead the real economy by nine to 12 months and it constitutes a strong signal of reversal of the growth trend. It has recently experienced two peaks, in 2010 and in 2014, because of European Central Bank quantitative easing, higher inflows of liquidity in the economy and low oil prices, the euro exchange rate, and interest rates.
Since May 2017, it has evolved into negative territory, reaching its lowest point in October 2017 at -2.4% of GDP. Our last quarterly update showed a level of -1.7% of GDP in Q2.
Decomposition of our Credit Impulse indicator reveals that the largest drop has come from non-financial corporations while the decline in the flow of new credit from households and NPISH is more limited. Based on more recent data about credit published by the ECB, we can expect a slight increase in the flow of credit from NFC at the start of Q3, but the trend remains weak and lower than in the euro area.
In July, year-on-year lending to NFC rose 1.2% in Italy, versus 4.1% in the euro area.
This sluggish trend in credit – which is certainly set to last – can be explained by NFC facing higher difficulties in light of rising interest rates, a deteriorating global trade environment, and an overly strong nominal euro effective exchange rate.
Qualitative data tends to confirm this negative view about the Italian economy. The Bank of Italy’s Ita-Coin, which leads industrial production by four months, is close to zero, indicating that a sharp decoupling from most other euro area countries has been taking place since Q3.
In more details, PMI have flagged the risk of a technical recession in H2 while business expectations are down to a five-year low. This confirms the scenario of broad growth stagnation in Q3. It is our view that this will seriously complicate the budget equation in Q4.
That being said, investors should refrain from overestimating the risk of Italy’s “hot autumn”. The lack of a unified message from the government over its upcoming budget along with economic weakness and higher interest rates at the global level will certainly lead to higher volatility in the next two months, especially when the EU Commission communicates its judgment on the budget on November 30.
However, as long as the risk of an Italian exit from the EU is low, bond market tensions should be contained. In previous years, we have observed that rising 'Italexit' risks caused a massive sell-off, such as the one seen at the end of 2016/beginning of 2017 when the risk of euro break-up was above 20%.
After a new hiatus due to the leaked 5 Star-League coalition deal last Spring, foreign investors were back this past summer – particularly Japanese investors, who were net buyers of Italian bonds to the tune of around €30m in July.
As is often seen in politics, there is a sharp difference between words and deeds, and Rome's recent actions seem to favour a consensus approach. In a way, market discipline leads to fiscal discipline in Italy. For Italian politicians, the real test will be the March 2019 EU elections that could bring a populist majority in the EU Parliament and encourage a change of direction in EU policy.
In the meantime, Italy’s best interest is to stick to EU rules so the ECB remains the country’s foremost ally.
Latest Market Insights
Quarterly Outlook Q3 2022: The Runaway Train
- Central banks' attempts to kill inflation is a paradigm shift, which could end in a deep recession.
Tangible assets and profitable growth are the winnersWith US equities officially in a bear market, the big question is where and when is the bottom in the current drawdown?
Understanding the lack of investment appetite among oil majorsThe everything rally seen in recent quarters has become more uneven, as its strength is driven by commodities in short supply.
The pressure is on as the wind leaves the sailsWith cryptocurrencies in sharp decline, are we entering a crypto winter or is the bear market a healthy clean-up of the crypto space?
Why the Fed can never catch up and what turns the US dollar lower?Many other central banks are set to eventually outpace the Fed in hiking rates, taking their real interest rates to levels higher than the Fed will achieve.
Bank of Japan: Swimming against the tideThe Japanese economy has gone from the age of deflation to rapidly rising prices in no time, leaving the Bank of Japan in a pickle.
Green transformation detour and bear market hibernationWith the impending risk of global econonomic derailment, we share the five things investors need to consider in this new half year.
Crisis redux for the eurozone?Whether there's going to be a recession in Europe or not, the path towards a stable economy will be agonizing.
Technical Outlook: Gold, Oil and a remarkable multi-decade perspective on EquitiesThe Nasdaq bubble pattern, USDJPY resistance, crude oil uptrend losing steam and the technical outlook for USD.
China: the train of new development paradigm left the station two years agoChina is transiting to a new development paradigm, as they are hit by deteriorating terms of trade, a slower global economy and an uncertain future while continuing attempts to contain the pandemic.