Euro Macro: Italy’s budget talks take place while economic climate cools – Today the August manufacturing PMIs for the eurozone’s peripheral countries were published. They suggested that Italy’s economy is underperforming the eurozone as a whole and also other peripheral countries such as Spain. Indeed, Italy’s manufacturing PMI dropped by 1.4 points to 50.1 in August, while the eurozone aggregate fell by only 0.5 points, and Spain’s manufacturing PMI actually edged higher. During the three months since Italy’s new government was sworn in, the country’s manufacturing PMI has dropped by 2.6 points, suggesting that the industrial sector has lost considerable momentum. This means that the discussions about next year’s budget take place in a cooler economic climate, which would have resulted in a less favourable outcome for the budget balance even without any policy changes.
According to the latest estimates by the European Commission, Italy’s budget balance would be around -1.7% GDP this year and stabilise at that level in 2019 without any policy changes. Given the loss of economic momentum, these estimates would probably have to be revised to closer to -2.0%. Meanwhile, the government has to present its targets for economic growth and government finances by 27 September. Finance minister Tria is committed to keeping the budget deficit within the 3% ceiling of the European Commission, whereas the two populist government parties are pushing to implement their two flagship policy measures (a flat tax and an guaranteed income for all citizens), which would together cost around EUR 70bn (equal to 4% of GDP) and lift the budget deficit to well above this 3% limit. If Mr Tria is serious about keeping the deficit to 3% of GDP, only around a quarter of the government’s plans could be implemented, which would probably be unacceptable for the two political leaders. Even in the unlikely event that Mr Tria succeeds in limiting the budget deficit to 3% throughout this government’s term in office, Italy’s debt ratio (132% GDP in 2017) would probably not improve much and move up in the coming years. (Aline Schuiling)
Fed View: A slightly less hawkish FOMC in 2019 – Following the full Senate confirmation of Richard Clarida as Fed Vice Chair last week, we have updated our FOMC voter table (see here). The Committee has had a notably hawkish tilt this year compared with last year. While 2019-20 is also likely to see doves outnumbered by hawks, we expect the Committee to tilt somewhat less hawkish, with one or two hawks replaced by doves. But this is unlikely to be enough to derail Fed rate hikes, and our base case continues to be for a further four rate hikes from the Fed, taking the fed funds rate to 2.75-3.00% by next June. Based on our neutral rate assumption of c.2.5%, this would be a modestly restrictive policy setting. While financial markets are now almost fully priced for a September hike, conviction in rate hikes is less strong further out, with c.65bp of the 100bp in tightening that we expect now priced in. The Bloomberg consensus of economists, in contrast, now projects a further five rate hikes rather than the four that we project. (Bill Diviney)