ECB Leaves Rates Unchanged, Significantly Downgrades 2013 Economic Forecast; Is Italy Falling Into the Abyss?

Earlier today the ECB left its benchmark rate at a record low .75% stating the rate was "very accommodating". What's more interesting is the ECB's Significant Downgrades To Growth And Inflation Forecasts.
The ECB downgraded its 2012 GDP forecast to a range of -0.6% to -0.4% from -0.6% to -0.2% previously, its 2013 GDP forecast to a range of -0.9% to 0.3% from -0.4% to 1.4% previously, and said its 2014 GDP forecast was for a range of 0.2% to 2.2% growth in the euro area.

On inflation, the ECB forecasts 2.5% inflation in 2012 versus a range of 2.4% to 2.6% previously. 2013 inflation forecasts were lowered to a range of 1.1% to 2.1% from 1.3% to 2.5% previously. In 2014, the ECB sees inflation in a range of 0.6% to 2.2%.
In the Q&A period following the meeting, ECB president Mario Draghi refused to answer the first question from a reporter regarding whether Italy is falling into the abyss.

Is Italy Falling Into Abyss?

Draghi would not address the question, but I will. Let's take a look at the Markit/ADACI Italy Services PMI® released yesterday, for clues regarding the abyss.
Key Points

  • Business activity and new work fall at accelerated rates
  • Steepest decrease in employment since June 2009
  • Input price inflation weakest for a year

Output across Italy’s service sector decreased at a marked and accelerated rate in November, as highlighted by a drop in the seasonally adjusted Markit/ADACI Business Activity Index – which is based on a single question asking respondents to report on the actual change in business activity at their companies compared to one month ago – from October’s reading of 46.0 to 44.6. That stretched the ongoing sequence of contraction to a year-and-a-half.

Contributing to the decrease in activity was a further reduction in the volume of new business placed with Italian service providers in November. The latest drop was sharper than one month before, and attributed by the survey panel in part to lower disposable incomes and a lack of credit.

With incoming new work decreasing, services firms directed more resources towards the clearing of backlogs, which fell for the twenty-first straight month in November. Moreover, the rate of decline was the fastest since August 2009. That was despite a considerable decrease in operating capacity within the sector, as businesses continued to cut staff numbers over the month. In fact, the decline in employment was the most pronounced since June 2009 and close to the series record. Panellists commented on reduced working days and the non-renewal of temporary contracts.


Phil Smith, economist at Markit and author of the Italy Services PMI® said:

“These data, showing business activity at service providers contracting at a marked and accelerated rate in November, mark a turnaround from the general trend seen in recent months when the pace of decline had eased steadily. Furthermore, a sharper decrease in new business inflows points to further weakness in coming months and adds to the suggestion that Italy’s largest sector is some way off a return to growth. Firms were quick to react to the renewed downturn, reducing employment levels at near survey-record pace over the month amid efforts to lower costs. The sharpest decrease in backlogs since August 2009 shows that there remains a substantial degree of excess capacity, giving businesses more room to cut staff numbers.”
I believe that answers the question. More specifically, "Yes, Italy has fallen into the abyss." Expect France to fall into the abyss as well, and expect Spain and Greece to stay in the abyss.

Draghi might have spooked everyone if he gave the answer I just did. Thus, it's no wonder that he failed to address the question.

My answer also explains the significant downgrades in the overall eurozone forecast (likely way too optimistic still).

Mike "Mish" Shedlock


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