Bank of Italy revises GDP growth forecast up

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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 percent this year and should remain above 1 percent in the next two years, Visco said Saturday. In January the Bank of Italy forecast GDP growth of 1.4 percent for 2018 and 1.2 percent for the following year.

“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,” according to the central bank governor.

Visco’s projection for this year matches the 1.5 percent foreseen by the European Commission, which predicts 1.2 percent 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 percent of gross domestic product.

“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 euros ($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 euros 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.

In the coming weeks, the European Central Bank plans to publish new guidelines requiring lenders to better protect against loans that turn sour, a move that makes additional bad debt reduction necessary to lower banks’ risks and funding costs, Visco said.

The governor called for measures that “take into account the starting conditions, are sustainable, and do not have potentially destabilizing procyclical effects.” They should also ensure a level playing field for banks operating in different environments, especially in terms of a swift and efficient civil justice system, according to the Bank of Italy governor.

Visco also urged improvements among the institutional arrangements of the European Union and of the euro area. “Diminished trust among member states has led to a sterile conflict between calls for risk reduction versus those for risk sharing. These proposals are instead complementary,” he said.