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Macro Outlook: The US rate cut cycle has begun
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Chief Investment Strategist
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Credit Impulse Update: Italy
Christopher Dembik
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.
Our Credit Impulse indicator for Italy represents the flow of new credit from the private sector as a percentage of GDP. To calculate it, we use the variation of the stock of loans held by the non-financial private sector (Nonfinancial Corporations and Households & NPISH) on a quarterly basis and we calculate a second derivative which is finally expressed as percentage of GDP.
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.
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.
In the immediate future, the Italian government has every interest in respecting its European budget commitments and sending a reassuring message to the market as it will need very favourable market conditions to face the massive maturity wall that will reach about €300bn in refinancing in 2019.
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.
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.
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