Global Insight Perspective
The economy continued to strengthen in the third quarter of 2006, although it was primarily due to a surge in stock levels.
The third-quarter GDP data confirm Global Insight’s view that the pace of the recovery has peaked.
Our growth forecasts for both 2006 and 2007 remain intact, at 1.7% and 1.3%, respectively.
Italy’s economy continued to strengthen in the third quarter of 2006, although it was primarily due to a steep inventory build-up, according to a final estimate from the statistics bureau, ISTAT. Real GDP grew by 0.3% quarter-on-quarter (q/q) after having risen 0.6% (upwardly revised from 0.5% q/q) in the second quarter of the year. The economy performed as expected, and thus Global Insight still expects real GDP to grow by 1.7% in 2006, its strongest performance since 2001. The annual comparison was still solid, with real GDP rising by 1.7% year-on-year (y/y), unchanged from the second and first quarters of 2006.
The breakdown of GDP by expenditure revealed that solid consumer spending growth and a sharp rise in inventories were the major growth drivers in the third quarter, which offset a large drag from net exports. A marked rise in inventories boosted the overall q/q growth rate by 1.3 percentage points in the third quarter. We believe that the increase in stocks was not deliberate, and was probably the result of lower-than-expected export sales in the third quarter. This could imply a downwards correction in inventory levels in the final quarter of 2006 that would dampen overall economic growth to just 0.1% q/q from the reported 0.3% q/q in the third quarter.
On the output side, there was a positive contribution to growth from services and, to a lesser extent, industry. Specifically, service-sector output expanded by 0.3% q/q and 2.3% y/y in the third quarter and industrial output by 0.1% q/q and 0.7% y/y. Meanwhile, agricultural activity edged up by 0.1% q/q, but was 5.8% lower than it had been a year earlier.
Private consumption growth accelerated to 0.6% q/q and 1.9% y/y in the third quarter of 2006, from 0.3% q/q and 1.7% y/y in the second. It is likely that spending on services remained healthy in the third quarter, while demand for goods appeared to falter. Retail sales were relatively subdued in the third quarter, while demand for new cars weakened. Indeed, the average level of new registrations contracted by 5.6% y/y in the third quarter, after having climbed 6.8% y/y in the second. Overall, consumer spending in the first three quarters of the year was supported by healthier consumer confidence, coupled with the favourable backdrop of recent limited tax cuts, low interest rates by past norms, and continuous employment growth. There was also moderate boost to consumption in the third quarter from spending related to the World Cup football tournament, which Italy won on 9 July.
Gross fixed capital formation lost significant momentum in the third quarter, declining by 0.3% q/q, and was up by just 0.2% y/y, after growing solidly in the first half of 2006, when it was 3.7% higher than it had been a year earlier. Within this segment, equipment investment contracted 0.7% q/q and was unchanged from the same quarter a year earlier. It had expanded 0.4% q/q and 2.3% y/y in the second quarter of 2006. Investment intentions appeared to be hit by weaker business confidence in the third quarter, while we believe that the unexpected accumulation of inventories and the steady appreciation of the euro in recent months lowered expectations about future output growth.
Net exports weakened significantly, lowering the overall GDP quarterly growth rate by 1.0 percentage point in the third quarter, after making a welcome positive contribution in the first half of 2006. Exports of goods and services contracted 1.7% q/q (but were still up by 3.3% y/y) in the third quarter, after rising very healthily in the first half 2006. The decline in export sales was partly a technical correction after several quarters of strong growth and the result of the steady appreciation of the euro, which has strengthened from an average of US$1.20 in the first quarter to US$1.27 by end-September. A stronger euro hits the Italian export sector hard, making it more difficult to compete with low-cost producers in Eastern Europe and the Far East. Italy specialises in highly price-elastic goods, notably clothing and footwear, as well as capital equipment. In the first half 2006, Italian export sales had been lifted by the relatively healthy global growth and stronger demand across the Eurozone, coupled with the markedly softer euro in the second half of 2005 and the first quarter of 2006. Meanwhile, growth in imports of goods and services strengthened from 0.2% q/q and 3.2% y/y in the second quarter, to 2.1% q/q and 5.4% y/y in the third quarter, reflecting firmer consumer spending.
Outlook and Implications
Global Insight’s 2006 Growth Estimate Remains Intact
The economy has revived after a stagnant performance in 2005, with real GDP estimated to have grown by 1.7% in 2006. We expect total domestic spending to exceed its very lacklustre growth performance in 2005, when it grew by just 0.1%, according to the final ISTAT release in 2005. Consumer spending has improved, aided by cheap credit and reasonable income gains (due to continued and firm employment growth). The upside of spending will continue to be limited by the impact of still elevated oil prices on real incomes and uneven consumer confidence in the final quarter of 2006. The main obstacle remains the current climate of consumer uncertainty, arising from concerns about the uncertain economic outlook and dismal public finances.
Meanwhile, fixed business investment appeared to turn the corner in the first half of 2006, boosted by low interest rates and an improved economic climate across the Eurozone. Despite the fall in total investment in the third quarter, we do expect resumption of gradual growth in the next few quarters as firms continue to renew their machinery and equipment after a prolonged period of depressed capital spending. Public spending is not expected to contribute to growth as the government battles with a large public-sector budget deficit.
Exports have revived in 2006 as a whole, partly as a result of stronger demand from the Eurozone and a technical rebound from a sharp contraction in exports at the beginning of 2005. However, the pace of export revival has slowed in the latter half of the year, following the renewed appreciation of the euro from the second quarter of 2006.
Growth Is Set to Slow in 2007
Real GDP growth is expected to fall back to 1.3% again in 2007, before accelerating gently to 1.4% in 2008. The slowdown will reflect the prospect of the euro making substantial gains against the U.S. dollar in the vicinity of US$1.40 by the end of 2007 and US$1.48 by end-2008. Consequently, export growth is projected to fall sharply in 2007 and remain subdued in 2008. Again, domestic spending is forecast to make moderate gains, as both consumers and businesses are expected to remain relatively cautious.
Household consumption is not expected to gain any momentum in 2007-08, despite the gradual dissipation of the oil-price shock and the prospect of labour tax cuts for low-income earners from the start of 2007. The fallout from the 2007 budget process is expected to have a negative impact on both growth and already fragile consumer confidence. The higher tax burden for top income earners and the unpopularity of the 2007 budget will continue to hurt consumer confidence well into 2007. It is likely that some cautious consumers could choose to save rather than spend the additional disposable income as they expect the economy to stumble again, while believing that additional fiscal tightening measures are inevitable.