Italy Is Still in the Danger Zone, and Europe Is Nervous

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A year after the election that led to Italy's populists taking power, the economic outlook is more precarious and the warnings across Europe are growing louder.

The euro area's third-largest economy saw a continued slump in manufacturing in February, days after confidence figures reinforced concerns that its recession will linger into 2019. The European Commission repeated criticism of the government's policies and said the fallout could hit the rest of the region.

The export-reliant country has been caught in a global slowdown that's ripped through Europe and dented output. Italy's troubles have been compounded by the coalition's expansionary budget designed to meet costly election promises.

That's left the economy looking at near-stagnation this year along with persistent double-digit unemployment and no progress on reducing its huge debt load. Economists forecast growth of 0.1 percent this quarter, but many say there's a high risk of another contraction.

Premier Giuseppe Conte, who came to power after the populists' election win on March 4 of last year, is dismissive of the warnings and staunchly predicts progress later this year. Finance Minister Giovanni Tria said Monday that restoring investor confidence is the biggest issue, but “all the conditions to do it are there.”

The squabbling coalition of Luigi Di Maio's Five Star Movement and Matteo Salvini's League -- sworn into office on June 1 -- has been beset by simmering tensions that could thwart major accomplishments. Media-savvy Salvini has used the rift to bolster his own stature, while Five Star's recent election losses have put Di Maio under increasing pressure.

Read More on infighting within Italy's coalition government

The European Commission, still battling with Rome over its budget, weighed in again on Feb. 27, criticizing the government and saying its actions “imply risks with cross-border relevance.”

The Brussels-based commission is not the first to warn of “contagion,” the dreaded notion of one country's woes sinking the rest of Europe. French Finance Minister Bruno Le Maire told Bloomberg: “Don't underestimate the impact of the Italian recession.”

“The European Union is right about Italy,” said Corrado Alberto, the head of Turin's entrepreneurs association Api, who runs a small business in the northern city. “Those who talk about stagnation are way too optimistic, we are facing a real recession.”

On Friday, statistics agency Istat reported a slight rise in unemployment in January, and said the economy grew 0.9 percent in 2018, down from 1.6 percent the year before. The closely watched debt load also rose.

Italian business lobby Confindustria said last week that this year will be challenging. The crunch could spread to retail consumption and to the credit market, further hobbling the country.

Despite all that, Italy's sovereign yields have dropped from the highs seen in 2018. They've averaged about 2.8 percent this year for the 10-year bond, down from a peak of 3.8 percent in October. That is partly due to the government rowing back on some of its budget ambitions, opting for a narrower deficit.

“The outlook remains highly uncertain and Italian companies seem to be aware of this,” said Vincenzo Longo, an analyst for IG markets in Milan. “The main risks remain linked to the international context and to the internal one, with the political uncertainty under the lens of investors.”

--With assistance from Lorenzo Totaro and Giovanni Salzano.

To contact the reporters on this story: Fergal O'Brien in Zurich at fobrien@bloomberg.net;Chiara Albanese in Rome at calbanese10@bloomberg.net

To contact the editors responsible for this story: Craig Stirling at cstirling1@bloomberg.net, Kevin Costelloe, Dan Liefgreen

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