Italian economic growth confirmed at 0.1% q/q in Q4 2015, near-term growth prospects modest

The Italian economy performed disappointingly in the final quarter of 2015 when the rate of expansion slowed for a third straight quarter. According to a final estimate from the Statistics Bureau, seasonally and calendar-adjusted real GDP grew for a fourth successive quarter when the economy grew by 0.09% quarter on quarter (q/q), compared to gains of 0.19% q/q in the third quarter and 0.3% q/q in the second quarter.

The annual comparison was moderately positive, with real GDP up 1.0% year on year (y/y), and was the best performance since mid-2011. In addition, the economy grew by a provisional 0.6% in 2015 as a whole, a moderate but still welcome turnaround from drops of 0.4% in 2014 and 1.8% in 2013.

The Statistics Bureau revealed more detail about fourth-quarter GDP in terms of expenditure, suggesting a positive contribution from domestic spending. Aggregated domestic spending (excluding a change in stocks) made a positive contribution of 0.3 percentage point to the q/q change in real GDP. Encouragingly, consumer spending added 0.2 percentage points to the q/q change in real GDP, alongside a 0.1 point contribution from both public consumption and fixed investment. Meanwhile, a slower rate of accumulation in inventories (plus statistical discrepancy) was a drag equivalent to 0.4 percentage point to the q/q change in real GDP in the fourth quarter (after positive contributions of +0.2 points in the first three quarters of 2015). Finally, net exports provided a modest growth impulse (with exports rising by 1.3% q/q alongside a 1.0% q/q gain in imports), raising the q/q development in real GDP by 0.1 percentage point.

Importantly, positive real income effects triggered healthier consumer spending in the fourth quarter, but was limited, suggesting households remain cautious in line with still disrupted channels and challenging labour market conditions. Specifically, private consumption grew by 0.3% q/q in the fourth quarter, slipping below the gains of 0.5% q/q in the third quarter and 0.4% q/q in the second. In annual terms, it rose by 1.3% y/y at end-2015 and 0.9% in the year as a whole. Other spending indicators suggest mixed consumer spending intentions during the fourth quarter. The nominal value of retail sales values decreased by 0.2% q/q and was just 0.9% higher when compared to a year earlier. Also, new car registrations grew at a brisk pace in the fourth quarter, up 16.4% y/y, and 15.2% in 2015 as a whole. In addition, spending on services appeared to be more stable, with Markit's purchasing managers' index (PMI) reporting service-sector activity was in positive territory throughout the second half of 2015.

Overall fixed investment grew by 0.8% q/q between the third and fourth quarters, the best performance since mid-2010, and was 1.6% higher than a year ago. Better fixed investment was due to a sharp gain in spending on transport equipment and to a lesser extent construction activity. However, machinery and equipment investment failed to take off, after several quarters of depressed activity. Clearly, the industrial investment climate remains uncertain. Importantly, firms are expected to raise their investment plans during 2016–17, in line with a moderate pick-up in growth both at home and abroad, as well as rising capacity utilisation. According to the European Commission's business and confidence survey, capacity utilisation in industry stood at 75.5% on a seasonally adjusted basis by the fourth quarter of 2015, above 73.9% at end-2014 and the survey average (from 1990) of 74.9%. Nevertheless, the industrial investment climate still faces some strong headwinds, namely some firms enduring tight financial results and a still-laboured recovery from Italy's longest post-war recession. The recent oil-price retreat will help relieve some pressure on companies' margins, which will provide some support to investment intentions. However, we suspect disrupted credit channels are preventing a more aggressive upturn in the investment cycle.

Outlook and implications

The loss of growth momentum in the second half of 2015 was a surprise, particularly with the economy still enjoying the fruits of extremely supportive external backdrop. The moderate GDP developments throughout 2015 provide further evidence the recovery in Italy remains vulnerable, and the growing economic and financial tensions across the globe signify a significant risk to the 2016 outlook. The latest survey data for both economic sentiment and PMI developments during early 2016 are disappointing, and suggest a limited pick-up in growth in the first half of 2016 after slowing steadily in the second half of 2015.

We expect economic growth to pick up modestly in the first half of 2016, probably to 0.2% q/q, with consumers taking the lead. The positive backdrop of recovering real household incomes as a result of marginal consumer price developments, falling energy costs and the abolition of property tax on primary residences will help to sustain the recovery in consumer spending throughout 2016. The boost to household purchasing power led to recovering consumer confidence during 2015, with households expressing more confidence about the economy and both their current and future personal situation. Clearly, consumers are able to lift their spending, attracted by generous pricing and boosted by recovering real incomes, and this theme will remain intact throughout 2016.

The mixed survey data and economic growth slowing for a third successive quarter by end-2015 will encourage Prime Minister Matteo Renzi to take a more belligerent stance against the European Commission about the need for more fiscal muscle to revive the flagging recovery. Clearly, Renzi is increasingly frustrated about the slow-burning economic recovery, and wants to further shift the focus of fiscal policy from austerity to growth. He believes that the recovery has to be sustained and encouraged and he will argue that Italy needs an additional fiscal shock to protect the recovery during 2016 from a troubled global economy, not helped by heightened financial volatility in recent months. We have argued that the government and central bank's growth projections of around 1.5% for 2016 are too high, and look even more daunting after the disappointing fourth-quarter 2015 GDP developments. Real GDP growth is likely to be limited to 0.9% during 2016.

Therefore, we argue that Italy is on course to overshoot its near-term general government budget deficit targets. The relatively comfortable 2016 fiscal stance and weaker than anticipated growth developments suggest that Italy will miss its headline deficit targets previously agreed with the Commission. The government expects the general government budget deficit to stand at 2.4% (up from a previous forecast of 2.2% and before then 1.8%) of GDP in 2016 from a confirmed 2.6% of 2015.

The government admits that the downward trajectory in the deficit-to-GDP ratio is likely to be more gradual because the government intends to strengthen growth. Renzi hopes that the Commission will grant Italy more fiscal flexibility as a reward for the country's labour market and banking sector reforms. However, the Commission will note that Italy is failing to rein back its public debt ratio, which rose again to 132.6% of GDP in 2015 from 132.5% in 2014.