National accounts show that Italy’s GDP expanded by a strong 2.7% q/q in Q2, an improvement from the 0.2% increase in Q1. As expected, growth in Q2 was driven by a strong recovery in services activity and household spending, which have been expanding since May, when most restrictions were lifted. Moreover, manufacturing activity remained solid, growing by around 1% over the quarter.
Leading indicators are not showing any meaningful slowdown in activity. Google mobility data continue to show strong improvements in retail and recreation mobility, while the composite PMI increased in August to 59.1, the highest level in over fifteen years. Moreover, the ISTAT business and consumer confidence scores only dropped marginally. Overall domestic demand is expected to remain solid in Q3, with quarterly GDP forecast to rise by around 2.5% q/q, only slightly lower than in Q2. But the outlook is less bright for Q4, when we see the Italian economy expanding by around 1%, but uncertainty remains high.
The Italian government has made clear vaccination progress and has recently made Covid “green passes” compulsory for most public and private sector workers, aiming to further incentivize vaccine uptake. However, our forecasts remain highly dependent on the evolution of the pandemic. A potential reimposition of restrictions or a sharp deterioration in sentiment as a result of a worsening health situation could postpone the recovery. Supply side issues are the other main headwind for the recovery. Italian industry so far has been faring better than that of other countries, such as Germany. But with global supply chain problems lingering longer than expected, the industrial sector is unlikely to contribute meaningfully to the recovery in H2 this year.
Italy’s GDP loss since Q4 2019 is now close to that of Germany and France. But developments related to the Delta variant are delaying, although not derailing, the economic recovery of eurozone countries.
NGEU will provide some positive support
The Recovery and Resiliece Plan entails additional spending worth 10% of GDP until 2026 alongside a package of ambitious structural reforms. According to our simulation, this spending could directly add 1.5%-2% of GDP in the medium-term. But the impact could be larger if the resources are allocated efficiently by targeting high-impact productivity measures and human capital, and if the structural reforms are successful. In that case, efficient allocation could boost average GDP growth to 1.3% from 0.7% over the next 20 years. However, we have only incorporated the direct effects of the spending increase in our baseline because we think the reform agenda has a low probability of success. In Italy, ambitious reform agendas that need strong, sustained political support typically face enormous political hurdles.
Growth will remain robust
Fiscal policy remains supportive: The government continues to maintain an accommodative fiscal stance. This support will push the 2021 deficit above 10% of GDP from 9.5% last year. Public debt will remain close to 155% of GDP this year. Still, we think the Italian bond market should be well supported over the coming quarters as EU loans and ECB programmes limit the net issuance of Italian bonds.
Labour market will gradually improve: Labour market data for July were less positive than in the previous months. But the worst is over, with hiring intentions remaining strong. However, we still expect employment to return to its pre-pandemic level in the second half of 2022, with the unemployment rate remaining above 9% for the next few quarters.
Temporary rise in inflation: Inflation in August rose above 2%, up from 1.9% in July. This dynamic, due mostly to energy base effects, is likely to continue until the end of this year. But we do not expect this to be the start of a trend. After averaging 1.6% this year, we see inflation moderating to 1.2% in 2022. However, the recent increase in gas prices could prompt us to revise up our inflation forecasts for the coming months.
Trade is recovering: Trade in goods is recovering strongly, with merchandise exports already returning to 2019 levels. However, services have performed much worse due to restrictions on tourism. Our baseline assumes a partial recovery in tourism and our Tourism Tracker for Italy has been slightly above the levels seen last summer. Domestic tourism should remain robust this year and international tourism is forecast to recover more strongly in 2022. We expect export volumes to rise 13% this year and then grow a further 8% in 2022.