Italy’s economic outlook worsens in the face of inflation

Behind the counter of F.lli Gondola, a café-bar and pastry shop in Frattamaggiore, owner Salvatore Gondola keeps a photo of Italian footballer Lorenzo Insigne.

Insigne, who grew up in this small town north of Naples, and his fellow Azzurri players captured the hearts of the nation when they won the European Football Championship against England last year – a fitting symbol for a country rebounding from a devastating pandemic.

Italy entered 2022 poised for a year of sustained growth and structural reform, supported by the assured leadership of Prime Minister Mario Draghi and the injection of funds from the EU. A once-in-a-generation effort to tackle its chronic weakness and lift its long-term growth trajectory, funded by a €191 billion tranche of the EU’s €750 billion Covid recovery plan, was in progress.

On and off the pitch, the glory faded quickly. The Azzurri missed out on World Cup qualification after an embarrassing loss to North Macedonia and the economic outlook has become so bleak that there is the possibility of a recession this year.

Coffee bar owner Salvatore Gondola, who saw sales fall and costs rise in 2022 © Amy Kazmin/FT

Any momentum built up in 2021 has been hampered by soaring food and energy prices, which are squeezing household incomes and hitting fragile small businesses. “Today is tough, really tough,” Gondola said. “It’s like during the Covid. The only difference is that this time it’s without a mask.

Italy is not the only troubled European economy. Brussels recently cut its forecast for GDP growth in the EU this year to 2.7%, down from an estimate of 4% in February. Inflation is higher in the Eastern economies, Germany and the Netherlands.

But Italy is heavily dependent on Russia for its energy, which makes it vulnerable to conflict in Ukraine. “Some countries are more exposed than others,” said Lorenzo Codogno, former director general of Italy’s treasury. “Among large countries, Italy is as exposed as Germany, and probably even more so, to high energy costs. . . This is a massive terms of trade shock for consumers, which means the whole country is getting poorer. An agreement signed with Algeria to supply gas from North Africa will take years to bear fruit.

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The economic slowdown – and expectations of rate hikes from the European Central Bank from July – are rekindling concerns about the health of Italy’s long-term finances. With the second highest debt-to-GDP ratio after Greece and the highest public deficit of any major eurozone economy, Italy’s position is precarious.

Markets clouded over his outlook. The spread between Italy’s 10-year bond yield and Germany’s, seen as a barometer of political and economic risks in the eurozone, has climbed as much as 2 percentage points in recent weeks, its wider since the early stages of the pandemic when investors dumped riskier European government debt. “It’s going to become a very tricky environment,” Codogno said.

Italy is on the way to fiscal consolidation. A budget deficit target of 5.6% is forecast for this year, down from 7.2% recorded last year. But economists have warned that a sharp slowdown in growth will cast doubt on the deficit.

“If GDP is going to weaken significantly, the momentum doesn’t look pretty,” said Lucrezia Reichlin, professor of economics at London Business School. “The market has now become quite pessimistic and a possible recession in 2022 is something many people are waiting for.”

The influx of EU funds for investment is a positive element. Italians have also accumulated higher than usual savings during the lockdowns, which can now be drawn down to support consumption. But the impact will fade and the hit to disposable income in the coming quarters should, according to Codogno, be “massive”.

Line graph of consumer confidence index showing that Italian consumer confidence is rapidly collapsing

The inhabitants of Frattamaggiore are already feeling the pinch.

Sosso Fardello, 74, a public transport retiree living on a fixed monthly pension of €1,500, cut virtually all discretionary spending after his energy bills rose. “We have to think about everything we buy and what is necessary to live,” he said.

The Draghi government this month imposed a one-time tax of 25% on the excess profits of energy companies to generate funds to protect millions of financially vulnerable families, including pensioners, with energy subsidies and a one-time payment of €200 in cash.

Pensioner Raffaele Rega, 74, who worked at a shoemaker, said such measures were not enough. “Our pension is just enough to survive and pay for food.”

Gondola – who runs his pastry shop with his brother, brother-in-law and nephew – said he struggled to ensure the business generated enough surplus to support four families. Monthly energy bills that averaged €1,200 are now €1,600; the small paper trays on which they serve the pastries have recently doubled in price; sales are down 30% since January.

Gondola had no choice but to pass on this cost increase to its customers, raising the price of a coffee from 80 cents to €1.20, and a 1kg fruit tart from €13. at €15. He has discontinued his largest 1.5kg pies, as his customers can no longer afford them. “We’re all trying to squeeze small pieces out of a smaller cake,” Gondola said.

Additional reporting by Martin Arnold in Frankfurt