Italy Country Risk Report Q4 2018
Italian politics is set for a large upheaval, with the country led by the populist Five Star Movement (M5S) and League (LN), representing the first time that a major European power has been ruled by a populist force since the EU's inception.
The recent growth uptick in Italy will prove to be cyclical. Growth will slow to sluggish trend levels over the next few years.
The Italian export machine will continue underperforming comparable eurozone peers in the coming years, due to long-standing competitiveness issues and the country's rigid labour market.
The likelihood of an incoming populist administration bodes ill for Italy's fiscal position, with the deficit set to widen considerably in the coming years. Italian debt sustainability poses one of the most significant systemic threats to the macroeconomic stability of the eurozone.
Monetary policy will remain loose in the eurozone in 2018 and 2019, as core inflationary pressures fail to pick up substantially and economic data releases increasingly point towards a growth slowdown.
While interest rates are unlikely to be hiked until the final quarter of 2019 at the earliest, European Central Bank (ECB)'s asset purchase programme (QE) will end in December 2018.
Major Forecast Changes
We now see real GDP growth coming in at 1.2% in 2018, 1.1% in 2019 and 1.0% in 2020, from 1.2%, 1.0% and 0.8% previously, on the back of our expectation for government spending to contribute more substantially to growth.
Budget proposals from both parties have rightly spooked investors, and suggests a wider fiscal deficit. This means we now forecast the budget deficit to reach 3.0% of GDP in 2019 and 2.9% in 2020, from 2.8% and 2.9% previously for 2019 and 2020.
The recent rise in bond yields highlights underlying government debt and political risk in the eurozone. While a region-wide downturn is not our core scenario, there is a growing possibility of a substantial drop in growth and rise in risk premiums.
Although we expect the ECB to take a cautious and gradual approach to tightening, in part due to vulnerabilities of highly indebted eurozone countries such as Italy, it is still uncertain how bond markets will react. With low borrowing costs a crucial anchor of stability, even a modest rise in interest rates may prove problematic.
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