We continue to expect flat GDP growth in Q3 and a positive print in Q4 (+0.2% q/q). The growth profile appears to be better balanced between domestic and external demand, raising hopes that the recovery may have some momentum. Political instability remains a major downside risk.
A new round of structural reforms is essential to a steady lowering of unemployment in the medium term. However, rebalancing at play within the working-age population is likely to support the cyclical adjustment of the unemployment rate, which is likely to gain traction as the economy improves.
For banks, the asset quality review might trigger an increase in NPL coverage: With the asset quality review looming, Italian banks are under pressure, given their sizeable stock of NPLs and relatively lower levels of coverage. Moreover, recent actions by the Bank of Italy suggest that coverage will increase further. Although net inflows of NPLs have shown some signs of improvement, these are driven mainly by write-offs and outflows rather than the actual progress of the performing book.
We estimate the two large banks might require provisioning top-ups of €5bn: On a static book, we calculate that the two large caps might need an additional €5bn, if we apply the same approach taken by the Bank of Italy during the last sector-wide inspection. We see this as manageable, but we estimate that it would still shed an additional 26% of pre-provision profits, on average, for Intesa and Unicredit.
Stricter rules on banks’ leverage ratios and on CCPs’ risk control measures might have the potential to affect the Italian repo market in terms of banks’ borrowing capacity and its role in providing the “plumbing” for the Government Bills and Bonds Markets. While risks are not negligible, we envisage other factors that may have a role in safeguarding the proper functioning of the Italian repo market.
Looking at the government bond market, the Fed’s dovish stance and more actions likely to come from the ECB should benefit peripheral bonds. Despite the Italian Treasury’s decision to increase debt issuance we remain constructive on Italy in the near term. Political instability remains the main risk, especially in terms of implications for the sovereign rating.
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