In 2019 Italy is on course to raking in its worst GDP growth reading since 2014. After slipping into recession in H2 2018, we expect the economy to expand by a meagre +0.2% this year, down from +0.8% last year. While positive support from the external sector should strengthen going forward, thanks to the Chinese stimulus propping up export demand, Italian domestic demand should remain muted at best as heightened policy uncertainty and elevated borrowing costs will weigh on hiring and investment decisions. After all, we expect budget tensions to reemerge by fall at the latest when Italy is due to submit its 2020 budget draft. With the 2019 budget deficit nearing the -3% of GDP mark, fiscal tightening will be required to reign in public finances. As the Lega/M5S coalition will once again test the EU’s patience, rising spreads and the lingering threat of a sovereign rating cut should act as key disciplining factors to bring about a fiscal policy rethink. However, given the expected inability of the Lega and the M5S to agree on unpopular fiscal saving measures we see a rising probability of fresh elections before year-end.
