Italy Outlook Improves, But Risks Still Remain

The Bank of Italy expects the nation’s economy to expand in 2018 at the same pace as last year since monetary policy “is working” and the ongoing reduction of economic slack has strengthened confidence, Governor Ignazio Visco said.

The central bank expects Italy’s gross domestic product will expand about 1.5% this year and should remain above 1% in the next two years, Visco said Saturday. In January the Bank of Italy forecast GDP growth of 1.4% for 2018 and 1.2% for the following year, Bloomberg reported.

“The virtuous circle of supply and demand is gaining momentum: the rise in households’ disposable income and the decline in firms’ spare capacity mean that the improved outlook is increasingly translating into higher consumption and investment,” Visco, who sits on the European Central Bank Governing Council, said in a speech at the annual Assiom-Forex conference in Verona.

He said that while the risk of deflation has been averted “it is proving difficult to push up inflation expectations. Exchange rate volatility poses one of the main risks to the inflation outlook, also given the high sensitivity of forex markets to the announcements of monetary and government authorities.”

Visco’s projection for this year matches the 1.5% foreseen by the European Commission, which predicts 1.2% growth next year. Under the current government led by Prime Minister Paolo Gentiloni, the economy’s recovery from its worst recession since World War II has gained pace and Italy’s public debt stabilized at around 132% of gross domestic product.

  Need for Tax Reforms 

“To strengthen growth in the medium term, further steps must be taken towards structural reforms, improving public services, and rationalizing and stabilizing the tax laws,” Visco said. “An increase in the public deficit is no substitute for reform and could prove counterproductive.”

Italy, which is holding bitterly contested general elections on March 4, has the euro region’s second-highest debt load after Greece. Political leaders are already hinting at a second round at the polls if no majority is reached. Potential political instability may unnerve markets that are still dealing with the consequences of Brexit.

The economic environment is helping banks continue to strengthen their balance sheets and reduce their non performing loans, Visco said, urging lenders to take the opportunity and push forward to recover profitability and competitiveness. “Cutting expenses further, merging or entering into consortiums to exploit cost and revenue synergies, and investing,” should be priorities for banks, he said.

Progress in stabilizing the banking sector along with better-than-expected economic growth has restored investors’ appetite for Italian assets. Gains have been driven by banks. Lenders were back in the spotlight after the government committed as much as €17 billion ($21 billion) to wind down two Veneto-region lenders last year, and nationalized Banca Monte dei Paschi di Siena SpA. Those actions addressed what were considered the main systemic risks for the Italian banking industry.

Still, Italian banks are weighed down by more than €270 billion of non-performing loans, more than twice the amount of soured debts held by lenders in any other European Union country. Supervisors are pressing banks to sell off soured debt and free up funds for healthy companies to support growth.