Italy’s economic prospects sour as inflation bites

Behind the counter of F.lli Gondola, a coffee bar and pastry shop in Frattamaggiore, owner Salvatore Gondola keeps a picture of Italian footballer Lorenzo Insigne.

Insigne, who grew up in this small town to the north of Naples, and his fellow Azzurri players won the nation’s hearts when they clinched the European football championship against England last year — a fitting symbol for a country bouncing back after a devastating pandemic hit.

Italy began 2022 poised for a year of buoyant growth and structural reforms, underpinned by Prime Minister Mario Draghi’s assured leadership and the infusion of EU funds. A once-in-a-generation effort to tackle its chronic weakness and raise its long-term growth trajectory, funded by a €191bn chunk of the EU’s €750bn Covid recovery plan, was under way.

On and off the pitch, the glory has faded fast. The Azzurri missed out on qualification for the World Cup after an embarrassing defeat to North Macedonia and the economic outlook has turned so bleak that there is the possibility of a recession this year.

Coffee bar owner Salvatore Gondola

Coffee bar owner Salvatore Gondola, who has seen sales decline and costs rise over the course of 2022 © Amy Kazmin/FT

Any momentum built up in 2021 has been dented by soaring food and energy prices, which are squeezing household incomes and battering fragile small businesses. “Today it’s hard, really hard,” said Gondola. “It’s like during Covid. The only difference is that this time, it’s without a mask.”

Italy is hardly the only European economy facing hard times. Brussels recently pared back its forecast for GDP growth in the EU this year to 2.7 per cent, down from a 4 per cent estimate in February. Inflation is higher in economies to the east, in Germany and in the Netherlands.

But Italy relies heavily on Russia for its energy, leaving it vulnerable to the conflict in Ukraine. “Some countries are more exposed than others,” said Lorenzo Codogno, former director-general of the Italian treasury. “Within the major countries, Italy is as exposed as Germanyand probably even more, to high energy costs. . . It is a massive terms of trade shock to consumers, which means the whole country becomes poorer.” A deal signed with Algeria to provide gas from north Africa will take years to pay off.

The economic downturn — and expectations of rate increases from the European Central Bank beginning in July — are reviving concerns about the health of Italy’s longer-term finances. With the second highest debt-to-GDP ratio after Greece and the highest government deficit of any major Eurozone economy, Italy’s position is precarious.

Markets have grown gloomier on its prospects. The spread between Italy’s 10-year bond yield and Germany’s, considered a barometer of political and economic risks in the euro area, has climbed as high as 2 percentage points in recent weeks, its widest since the early stages of the pandemic when investors dumped riskier European government debt. “It’s going to become a very delicate environment,” Codogno said.

Italy is on a path of fiscal consolidation. A target budget deficit of 5.6 per cent is forecast for this year, down from the 7.2 per cent recorded for last year. But economists warned that a sharp slowdown in growth would raise doubts about the deficit.

“If GDP is going to weaken substantially, the dynamic doesn’t look pretty,” said Lucrezia Reichlin, an economics professor at the London Business School. “The market has now become quite pessimistic and possible recession in 2022 is something many people expect.”

The influx of EU funds for investment is one positive. Italians also amassed higher-than-usual savings during lockdowns, which can now be drawn down to sustain consumption. But the impact will fade and the hit to disposable income in the coming quarters is, according to Codogno, set to be “massive”.

Line chart of Consumer confidence index showing Italian consumers' confidence is sinking fast

Residents of Frattamaggiore are already feeling the pinch.

Sosso Fardello, 74, a retired public transport worker living on a fixed €1,500 monthly pension, has cut out virtually all discretionary spending after his energy bills surged. “We have to think about everything we buy, and what is necessary to live,” he said.

The Draghi government this month imposed a 25 per cent windfall tax on the energy companies’ excess profits to generate funds to cushion millions of financially vulnerable families, including pensioners, with energy subsidies and a one-time €200 cash payment.

Pensioner Raffaele Rega, 74, who worked at a shoemaker, said such measures were not enough. “Our pension is just enough to survive and pay for food.”

Gondola — who runs his pastry shop with his brother, brother-in-law and nephew — said he was struggling to make the business generate enough surplus to sustain four families. Monthly energy bills that used to average €1,200 are now €1,600; the small paper trays on which they serve pastries recently doubled in price; sales are down 30 per cent since January.

Gondola had no choice but to pass on these rising costs to his customers, increasing the price of a coffee from 80 cents to €1.20, and of a 1kg fruit tart from €13 to €15. He discontinued his larger 1.5kg tarts, because his customers cannot afford them any more. “We are all trying to squeeze little pieces from a smaller cake,” Gondola said.

Additional reporting by Martin Arnold in Frankfurt

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