GDP growth down

After the dangerous rollercoaster ride of the last three years, the Italian economy is once again sliding back towards the modest growth rates that had characterised it in previous decades (Chart A). The European economy is also suffering the same slowdown.

This is not happening as a result of new upheavals, which in 2023 in any case were not lacking but whose impact is limited for the time being, compared to the pandemic and the energy crisis. Instead, it happens as a result of the major response of policy to these previous adverse events and the resulting inflation: the rise in interest rates. It is precisely inflation and high rates that are the main reasons for the ongoing weakening of the Italian and European economy. In Italy, the gradual exhaustion of the boost due to the post-pandemic recovery also played a role: once the levels of expenditure that had to be renounced had been reached, the growth rates of consumption went down; in 2023, at a rate of about a quarter of that of 2022. The same phenomenon is affecting the service sector, driven until a few months ago precisely by the recovery of 'out-of-home' spending.

Rates up, inflation down

As expected, inflation in both Europe and America has decelerated but remains 'sticky', i.e. resilient, compared to the speed at which gas prices have fallen. The deceleration path that is bringing it closer to the shared target of +2.0% per year is still incomplete: it has already been a year since the peaks in the last months of 2022, a year since the gas price abruptly collapsed, allowing precisely the start of the descent of inflation (Chart B).

The reason for the slow progress is that, despite central bank interventions aimed at curbing inflation expectations, the usual effects of second round of previous energy price increases, on non-energy goods and services. This also fuelled inflation corewhich measures 'domestic' price pressures: it peaked in early 2023 and only recently started to fall again.

Inflation also in Italy core is declining, but there are still internal pressures holding back its descent: in 2024, the contribution of labour costs will remain large as a result of the strengthening of contractual wages lagging behind the rise in inflation (see Focus 1).

We have now reached a point where both the Fed, the leaderthat the ECB, the follower (which have raised rates by 4-5 percentage points) are pondering whether these increases are now sufficient to curb inflation. The markets believe so. On broadly restrictive values very high, if measured against the zero value to which economic activity had become accustomed until the first half of 2022.

The rate path incorporated in the CSC scenario confirms this reading: there will be no further hikes and from the middle of next year we will see limited cuts, still at restrictive levels. The risks to this scenario are tilted both to the downside and upside.

There is a non-zero probability that the ECB may bring forward the start of the cutback phase to early 2024, once the upcoming inflation data in the Eurozone and especially in Italy (where it will help a favourable 'base effect' in October), show that the +2.0% value is now very close, if not reached. That would be good for our economy.

However, on the other hand, there is also a significant probability that, across the Atlantic, counting on the proven resilience of the US economy, the Fed will decide to deal another blow to inflation, which is still above +3.0%. At that point, the risk is that the ECB, even with numbers that are very different in the Eurozone than in the US, will decide to follow the path of 'further hikes', to avoid repercussions on the dollar/euro exchange rate that would risk fuelling inflation again. That would be a blow to our economy, but also to the already sluggish European economy.

Expensive and poor credit

The channel through which the rate hikes are impacting domestic demand, and thus GDP, is through bank credit for households and businesses. On the corporate side, the cost of credit has risen abruptly; and this has lowered the demand for credit from businesses. What is more, some of them did not get the loans they asked for, because supply criteria have also been tight over the past year, given the worsening expectations on the economy and some difficulties of banks in the markets at the beginning of 2023, as shown by the BLS survey conducted by the ECB. The result is a heavy reduction in the stock of loans to Italian businesses (-6.2% per year) and a simultaneous sharp increase in borrowing costs (+€10.3 billion over twelve months, CSC estimates). Also suffering is the available liquidity in companies, which has rapidly thinned as companies have used up all that was in excess over the past year.

All this has an impact on investment decisions: less is made because, if there is not enough equity, investments cost more and there is not enough debt to pay for them. This is by no means new. On the household side, the path is quite similar, and goes through home mortgages and consumer credit.

As if this were not enough, the tightening of rates is causing problems to re-emerge, which we had stopped addressing. First, NPLs, i.e. 'non-performing' loans, have risen again in recent months because the rate of deterioration of old loans has increased: an alarm bell, which risks jamming the delicate credit mechanisms even more. Second, the liquidity of many companies may soon be low (see Focus 2), limiting current activity as well as investments. As a cascade, there is once again, after a long time, an increase in payment delays between companies, a symptom and consequence precisely of the fact that the availability of liquid resources in companies today is running out.

New risks from energy and raw materials

Energy commodities have recently been the focus of concern again. After two years of following with bated breath the sudden rises in the price of gas, which few knew about but everyone quickly learned to fear, the protagonist on the markets in recent months seems to be the price of oil again. Brent crude suddenly started to rise again during the summer months, reappearing above $90 per barrel: a decidedly high and counterproductive price for the world economy. In particular, for importing countries such as Italy, where households are already feeling the impact on their transport costs through the rapid increase in fuel prices. Which immediately enter into the calculation of inflation, in the energy component.

This was before the new Israeli-Palestinian war, which so far does not seem to be blowing the oil price any further. But this outbreak, which comes on top of the Russian invasion of Ukraine that has been going on for more than a year and a half now, increases the uncertainty on the global scenario. And it risks inflaming both gas and oil prices in the event of the war spreading to neighbouring countries.

International prices of other commodities, in particular those of metals and agricultural commodities, remain on a declining profile for the time being due to the global economic slowdown. A normal adjustment mechanism of the economic system. However, the declines are modest so far, compared to previous price rises, and thus prices non-energy remain at high levels compared to pre-pandemic levels: the additional cost for households and businesses remains.

Very complex international scenario

The shift of consumption from goods to services, the weakening of European industry, which gravitates around that of Germany, and the more difficult conditions for demand, especially for investments, due to the monetary squeeze and still high inflation, are holding back global manufacturing and this is reflected in the drop in world trade, which is also weighed down by the closure of China, the strengthening of the dollar (the currency of reference for a large part of trade), and the multiplication of trade barriers (over 3,000 in 2022, from less than a thousand in 2019).

The trade contraction in 2023 is fully captured in the latest available data and the CSC scenario calls, indeed, for a rebound in the final months of the year (Table A). If this materialises as expected, 2024 should see a return to expansion in world trade, albeit at a modest pace. This can only be good news for a processing and export economy like Italy's.

Second fact: the heterogeneous locomotive of emerging countries, the real engine of global growth, continues to run. Among these, China, despite all the recent uncertainties, continues to grow by several points more than the main advanced countries. And India, often overlooked as the second largest emerging economy, is becoming increasingly important. Instead, it is gaining space as a manufacturing power capable of attracting globally important production stages, even to the detriment of its emblazoned neighbour, as demonstrated by the assembly of smartphones designed in the USA.

A third relevant fact is that the gap between the dynamics of the US economy, which is strong and resilient, surprisingly even for US forecasters such as the Fed, and that of the Eurozone, which is instead cut to the bone and not doing any better than Italy's, is widening a lot. The main difference in the recent events affecting the two economies is that the US one was hit much less in 2022 by the gas price shock. And it did not have to face the difficult and still incomplete transition to reduce dependence on Russian gas.

In Europe, the difficulties of Germany, which had the greatest dependence on Russian gas and slipped into a moderate recession in 2023, weigh particularly heavily. The CSC's analyses (see Focus 4) show that the current crisis in Germany should have a more limited impact on Italy than in past episodes. For two reasons. First, because it is above all a recession from a fall in consumption and a slowdown in services, rather than from weakness in industry, which remains. Second, because the interconnections between Italy and Germany, while remaining strong, are weaker today than in the past.

Italy: only consumption and employment resist

In the CSC scenario, Italian GDP advances by just +0.7% in 2023 (Table B). And this is a change already fully achieved by mid-year. In 2024, it will be worse on average, +0.5%, despite a quarterly profile expected to recover.

This low growth is driven almost entirely by the dynamics of household consumption. Which, however, on a yearly average slow down in both 2023 and 2024, after high rates in 2022 that incorporated the recovery of pre-pandemic levels for various expenditure items, especially services. This year, consumption has been financed by a decrease in the propensity to save, given the weakness of real income and tighter financial conditions, while in 2024 it will be helped by the recovery of purchasing power, due to a strengthening wage dynamic and normalising inflation.

Italian employment, when measured in terms of full-time equivalent labour units (FTEU), on average over the two-year forecast period grows in line with GDP, although this year it grows a little more, thanks to the positive momentum of the first half, and next year less. In terms of heads, it grows at a faster pace in both years. The expansion in 2023 is now all set, and should be read in the light of the time lag compared to the positive GDP momentum recorded previously. The number of people in employment, which was already at a standstill in the summer, will remain substantially stable in the coming quarters, only starting to rise again in the second half of 2024. Overall, these data and forecasts indicate that the Italian labour market is holding up well.

Investment, on the other hand, which in 2021 and 2022 had been the main source of growth in our economy, will brake sharply this year and then come to a halt next. With a sharp downward revision compared to the estimates for 2024 made by the CSC in its March report. There are many reasons for this. Construction will no longer act as a driving force as it did in the previous two years, when investment in the sector expanded extraordinarily, thanks to powerful tax incentives. Public investment is expected to decline in 2023 and increase only slightly in 2024: it does not therefore show the strong growth profile that could have been expected at the launch of the NRP.

A positive contribution of the NRP is indeed incorporated in these forecasts. The impact estimates that can be developed on the Plan indicate that a full implementation of the investments included in the PNRR can offer a very significant stimulus to growth in the two-year forecast period (and also in subsequent years; see Focus 5). But the postponement of work, as indicated in the NaDEF, suggests that the actual stimulus in the two-year period will turn out to be much less than that planned no later than last April. On the other hand, the opportunity represented by this Plan should not be wasted: raising the economy's growth potential over the medium to long term, thanks to the various planned reforms and the implementation of investments, is the crucial challenge of the coming years, to avoid a permanent return to low growth. And it is also to reduce the enormous public debt, relative to GDP.

Recent years show how sustained growth rates can have a beneficial effect on public debt. Between 2020 and 2022, public supports exceeded EUR 410 billion, almost 23 GDP points in 3 years. But the debt-to-GDP ratio increased by just over 5 points between 2019 and 2023. It would have been sufficient to limit the number of beneficiaries of certain bonuses to be able to safeguard the economic fabric and stop the ratio at 2019 levels.

In the coming year, the Stability and Growth Pact will become operational again on the basis of the new rules proposed by the European Commission or by reactivating the old ones (see Focus 3). Although the new ones appear to be a clear improvement on the past, in the absence of a centralised fiscal instrument at European level to stabilise the cycle in times of economic downturn, there is a high risk that the fiscal stance European (sum of national budgetary policies) is inadequate to the economic context, i.e. restrictive in a negative cyclical phase, as happened in the first half of the last decade, pushing the area into recession. The risks associated with the incomplete implementation of economic governance, in the long term, appear very high, especially for a country with a high debt burden like Italy.

Exports do not drive

Italy's terms of trade improve in 2023, markedly, after the collapse suffered in 2022. This is because gas and oil prices on average for the year are well below their recent peaks. And meanwhile, Italian export prices continue to show a moderate upward dynamic. This improvement in the terms of trade is a very positive factor because, with equal volumes of sales and purchases with other economies, it improves the country's trade balance, bringing the foreign accounts back into the black. Which thus return to being one of the elements of solidity of the Italian economy.

Recent data suggest, with some differences depending on the specific indicator by which trends are measured, that Italian production is substantially maintaining its price competitiveness. While it is true that Italian export prices are increasing, on average in 2023 compared to last year, it is also true that their variation is rather similar to the dynamics recorded by the prices of the main competitors on international markets.

In this scenario, which includes negative international trade this year, the expected dynamic of Italian exports remains barely positive in 2023 and then aligns with the recovery of world demand in 2024. This perfect alignment in 2024 comes after years in which our export growth exceeded that of world trade, i.e. years in which we gained market share. This process is expected to stop next year, but certainly not reverse: a sign that precisely the competitiveness of Italian products remains high, both in terms of price and quality.

The contribution to GDP growth from exports, measured, however, net of import trends, is zero in 2023. It then becomes barely positive again in the next year. Thus, foreign trade, on the whole over the two-year period, does not provide the strong stimulus to economic growth that has been seen in recent years and is even more needed now.