Italian decline moderates as length of recession breaks record

Second quarter Italian GDP has come in slightly better than expected, as the pace of contraction slows. But the recession has broken new records, as Italy has seen GDP fall for eight quarters.

Italian output shrunk by 0.2 per cent in the second quarter, down from a fall of 0.6 previous in the first. Economists had been forecasting a fall in GDP of 0.4 per cent.

Christian Schulz, senior economist, Berenberg:

Italy is still likely to be the worst performing large European economy for a third successive quarter if Spain confirms its 0.1% GDP contraction and France and Germany do not disappoint. But the worst of the crisis is over and Italian GDP should be growing again before the end of the year, backed by fading austerity and an export-driven recovery.

The political situation remains volatile, with the definitive conviction of Berlusconi for tax fraud potentially putting the coalition under Prime Minister Letta at risk again. However, the fiscal drag on domestic demand is fading. After almost 3% of GDP in cuts and tax increases under Monti last year, the Letta government has postponed the dreaded VAT hike and will probably abolish the property tax. It is also seeking to make good on the pledge to pay €20bn in arrears owed to the private sector, which might inject some liquidity into the economy.

These initiatives come at the cost of a likely overshoot of the fiscal target above 3.5% of GDP this year, but that is unlikely to have repercussions in the markets if growth returns, while Brussels will probably not react before next year. With the global macro backdrop brightening and austerity fading, Italy should return to growth in the second half of 2013.