Europe News

Italian stocks slide on reports of a sizable growth downgrade

Key Points
  • Reports of Italy cutting its growth target have been in the news lately. Last week, Italy's II Sore 23 Ore reported that the government is set to downgrade GDP along with introducing a package to boost growth.
  • The country slipped into recession when its economy contracted for the second consecutive quarter at the end of 2018.
Rauridh Laing | EyeEm | Getty Images

Italian stock markets fell Thursday morning after a report that Italy is set to cut its 2019 growth forecast from 1% down to just 0.1%.

Bloomberg on Thursday reported that Italy is preparing to cut its gross domestic product (GDP) forecast from an earlier target after similar reports in the Italian press last week.

Banking stocks plunged by nearly 1% with the wider FTSE MIB sinking 0.5% during morning deals. The euro hit session lows and the Italian 10-year bond yield rose three basis points to 2.56%. Meanwhile, Germany's 10-year government bond yield quickly slipped to just below zero as more and more signs of weakness in the euro zone start to emerge. This is the second time in two weeks that the German 10-year bond has slipped into negative territory.

The German government 10-year bond, an important benchmark for European fixed-income assets, is viewed as a safe haven for investors. In times of uncertainty and challenging market environment, investors tend to move their investments from riskier assets into safe havens like gold and government bonds. The bond yields hitting negative territory shows there is rising demand for the paper with uncertainty in the region, which includes a slowdown in Germany and deadlock among politicians on Brexit.

Reports of Italy cutting its growth target have been in the news lately. Last week, Italy's Il Sole 24 Ore reported that the government is set to downgrade GDP along with introducing a package to boost growth.

A planned package of measures designed to lift economic growth could boost this year's GDP to 0.2%, the paper said, allowing the government to submit to the European Commission a revised deficit-to-GDP target of 2.3%. That compares with a 2.04% forecast in Italy's 2019 budget law.

"It was only a matter of time until the Italian government would have to bring down its growth forecast and raise its deficit call," Florian Hense, European economist at Berenberg, told CNBC Thursday via email.

"We expect 0% GDP growth for 2019 and the deficit will likely be way beyond 3%. Expect the conflict with the European Commission to heat up after the European elections on 23-26 May. The elections may, however, also bring a welcome shakeup in domestic policies."

Italy in recession

The country slipped into recession when its economy contracted for the second consecutive quarter at the end of 2018. Gross domestic product fell a quarterly 0.2% between October and December, following a 0.1% decline in the third quarter, and was up 0.1% on an annual basis, national statistics bureau ISTAT reported in January.

The present Italian government — a coalition of the anti-establishment Five-Star Movement and the right-wing Lega — which took office in June has often pointed out that the country's economy has been weakening since early 2017 and has recently been hit by a slowdown in Italy's main trading partners.

The coalition approved an expansionary budget in December aimed at heading off the growing threat of recession.

The budget, which was watered down after European Commission said it would not lower Italy's high public debt, features a new income support scheme for the poor and allows people to retire earlier. It also slashes taxes for the self-employed.

Italy's public debt pile is 131% of its GDP, and at 2.3 trillion euros ($2.6 trillion) is the second largest in the euro zone.

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ECB's U-turn

Italian economic woes along with larger uncertainties around the world pushed the European Central Bank (ECB) to announce another series of cheap loans in March. The loans, aimed at stimulating bank lending is the third injection of stimulus of this kind from the ECB.

"There will be further pressure on the ECB to provide more support for at least the remainder of (President Mario) Draghi's tenure, with the April-July rate decisions looking ripe for a further dovish pivot from the central bank," Stephen Gallo, European head of FX strategy, told CNBC on Thursday.

"The euro is a straight jacket for the Italian economy, and the country's economic troubles of yesterday, today and tomorrow are further proof that the currency bloc was constructed backwards. Countries like Italy needed to reform their economies first before joining the single currency, not the other way around. But that's the EU for you," Gallo added.

CNBC's Holly Ellyatt and Silvia Amaro contributed to this article