UniCredit SpA surged after Libyan investors including its central bank boosted their stake in Italy's biggest bank and said they will invest more. The shares gained as much as 12 percent to 2.42 euros in Milan, valuing the bank at 32.2 billion euros ($42.4 billion). Libya's investment is ``good,'' UniCredit Chief Executive Officer Alessandro Profumo told reporters in Milan. ``It's a confirmation of their interest in our company, which they also consider to be very attractive.''

The investment may be worth much as 1.3 billion euros, according to a note by Centrosim analyst Marco Sallustio published this morning. It could allow Libya to obtain a seat on the bank's board. Central Bank of Libya, Libyan Investment Authority and Libyan Foreign Bank bought shares to boost their holding to 4.2 percent, the investors said in a statement late yesterday. They intend to buy as much as 500 million euros of securities that UniCredit plans to sell over coming months.

- - UniCredit is one of Europe's top 10 banks by market value, with a capitalisation of about $39 billion. It is second to Intesa Sanpaolo SpA among Italian banks.

-- In a U-turn on Oct. 5 it announced plans to boost capital by 6.6 billion euros. It will ask investors for 3 billion euros in a capital increase and offer shares rather than a cash payout on 2008 results, putting 3.6 billion euros instead in its own coffers.

-- UniCredit on the same day boosted its target for Core Tier I to 6.7 percent at the end of 2008 based on Basel II requirements from its previous aim of 6.2 percent. The figure was 5.7 percent at the end of June.

-- It also slashed earnings per share forecasts for this year to 39 euro cents from around 52 euro cents previously.

-- It is the Italian bank with the most foreign exposure. UniCredit gets about half its revenue from outside Italy and its conservative lending market.

-- UniCredit, whose units include Germany's HVB, is among market leaders in Germany and Austria.

-- UniCredit's share price has dropped about 62 percent since the start of the year, pushing it second to Intesa Sanpaolo among Italian banks. The DJ Stoxx European banks index has lost about 52 percent.

-- First-half net profit was 2.9 billion euros on operating income of 14 billion euros. Deposits from customers and debt securities totalled 639.8 billion euros.

-- The bank traces its origins back to 15th century Bologna. The current UniCredit resulted from the merger of nine of Italy's biggest banks in 1998, as well as the purchase of HVB in 2005 and Italy's Capitalia last year.

-- The biggest shareholder is the Fondazione Cassa di Risparmio di Verona Vicenza Belluno e Ancona, at 5 percent.

-- Libya now comes second with its combined 4.23 percent, followed by:

Fondazione Cassa di Risparmio di Torino with 3.83 percent

Carimonte Holding with 3.35 percent

Gruppo Allianz with 2.37 percent

Fondi Barclays Global Investors UK Holdings Ltd with 2.01 percent.

-- UniCredit is the biggest shareholder in powerful investment bank Mediobanca SpA with an 8.7 percent stake.

Italian Prime Minister Silvio Berlusconi pledged $5 billion over 25 years to Libyan leader Muammar Qaddafi in compensation for the occupation of the country in the 30 years before World War II.

Italy will pay $200 million per year to Libya in the form of investments in infrastructure. The money will finance the construction of a coastline highway that runs about 1,600 kilometers (994 miles) between the Egyptian and Tunisian borders.

``It's a full moral recognition of the damage done to Libya during Italy's colonial period,'' Berlusconi said after arriving at the airport in the Libyan city of Benghazi, where the two leaders met to sign the accord. ``This will end 40 years of misunderstandings.''

In a deviation from the measures seen in France and Germany, Italy has not created a fund for its rescue plan, with Finance Minister Giulio Tremonti stating that, "As of today, we estimate that it's not necessary to have a predetermined figure."......Italy is in stark contrast to other European nations by providing no firm capital commitments; however, the government's reluctance to create a rescue fund could partly be a reflection of the restraints imposed by its substantial public debt, which stood at 104% of GDP in 2007.

The Bank of Italy will also engage in a 40-billion-euro debt swap, taking on inferior bank debt for government bonds that can then be used to obtain financing from the ECB.

Or if your stomach hasn't been turned to much by Italy, then you could move on to the Spanish one, where the really notable thing you will find is the "vigour" of the contraction, this is an economic decline with "gusto":




Consumer and Business Confidence

One interesting detail about the data we have been seeing this September is the strange mismatch we are getting between the consumer and business confidence readings. The most recent surveys of consumer confidence in all the eurozone big four countries have been up, albeit from very low levels, seeming to suggest that consumer sentiment is very inflation-perceptions driven, and that the fall back in oil prices has brought almost instantaneous relief across the hearts and minds of eurozone consumers (although not perhaps their wallets, so don't be in too great a hurry to extrapolate this slight uptick in sentiment through to increased end consumption just yet, since there is still the availability of credit to think about):



On the other hand, business confidence continues to decline right across the big four, which simply reinforces my point about not being too eager to translate rising consumer confidence (however long it may last or not last) through to end sales for companies. In fact German business confidence declined to its lowest level since May 2005 in September according to the Munich-based Ifo institute's business climate index, which fell to 92.9 from 94.8 in August. As can be seen in the chart, it isn't exactly falling off a cliff, but it ain't far off.

So Where Do We Go From Here?

Well, as Frank Atkins suggests, a technical recession across the eurozone in quarters 2 and 3 would seem now to be more or less a done deal (that is, we could say that the eurozone recession technically started on 1 April 2008), and the real front-end-of-the-curve argument is, how long will it last? Now according to received wisdom (you know, the Bible as written on Kaiserstrasse and handed down - or perhaps read out at post rate-setting press conferences - to us mere mortals), growth should start to bounce back in the last quarter, and then a full recovery should begin in early 2009. But remember, this argument was brought to you by those who a mere three months ago were busy saying that the German economy was looking as safe as houses (although not, I should hasten to add, US houses, or Spanish ones for that matter) and looking at what has been happening in global financial markets over the last two or three weeks, I have to ask myself whether there is anyone left who can still recite this version of the authorsied psalter and manage to keep a straight face?

It could be that the zone as a collective entity will expand slightly quarter on quarter in the last three months of the year, I think it is far to early to start speculating on this, but what I do think we can say with almost categorical firmness is that growth in all of the big four eurozone economies is likely to remain weak throughout 2009 (and by weak I mean moving up and down around the zero percent mark, although in the Spanish case I think I would go so far as to say that it is quite unlikely that the economy will break zero in any of the four quarters), and that is really as far ahead as I am willing to speculate at this point. That is we may well see a pattern where one quarter of weak expansion is followed by another of weak contraction, as we have been growing accustomed to seeing in the Italian case since mid 2007. In a sense this is what a credit crunch plus excessive inflation means, and the only question is at what level the "barème" should be set. What I really do seem to be unable to find at this stage are any compelling reasons for thinking that we should anticipate any kind of rapid rebound, indeed it is far easier to think of reasons why we shouldn't.

Three key factors come immediately to mind in this context: the price of oil, the relative value of euro-dollar, and the availability of credit. The first of these three hits consumers directly (and producers indirectly since it becomes that much more difficult to sell), the second (a high euro, which we should expect to some extent to be the by-product of the continuing weakness in the US economy, although exactly where euro-USD will settle is one of the greatest incognitas of the current conjuncture ) hits export-dependent economies hardest (Italy and Germany come immediately to mind, but now arguably Spain has now become an export dependent economy, at least for the duration of its structural move away from construction dependence), while the third (credit availability) will affect the real economy as a whole, by restricting the ability of consumers and corporates alike to borrow, and thus finance acquisitions of one kind or another. Really each of these three merit an article in their own right. In comparison the fourth wild card - interest rate policy at the ECB - seems like rather small beer at the end of the day, and indeed the ability of the ECB to sustain (say) Spain's troubled banking system may constitute a far more important contribution from the bank at this point than a few quarter point reductions in the repo rate, at least in the short term. Of course, it is just this ability to continue to keep the Spanish banks afloat in the mid-term which constitutes another of the big eurozone forward-looking enigmas.

Taking The Eurozone Piece By Piece

One of the biggest obstacles to getting to grips with the economic issues facing the individual member economies of the eurozone is quite simply the inherent tendency to lump what are effectively apples and pears all together in one and the same basket. As as result we tend to hear very little (for example) about specific policy measures designed to handle the almost unique problems now facing the Spanish economy. Hence it is difficult for journalistic observers to understand just why it is that the Spanish banks most definitely do need some kind of special treatment (and indeed far more than they have been getting) from the ECB, or - to take another tack - why the terms of the Stability and Growth Pact Mark II (3% annual deficit limit, 60% debt to GDP maximum), should not be simply applied in blanket fashion, and why France may with some legitimacy say that the 2011 balanced budget target is not as urgent and pressing a matter for them as it is, say, for Italy, and indeed why it may be in the collective interest of the entire zone to go easy on France (and indeed Spain) in this context (more below).

But as I say, what we have here are apples and pears, and what we badly need is some sort of consensus typology of the individual national economies, on the basis of which effective policy could be developed. In each of the big four cases the problem is different, and the sooner we wake up to this the better.

Italy

The Italian situation is really most preoccupying, since output seems to have hit some sort of ceiling or other. As I suggest in this post, retail sales may well now have passed their historic peak as the problem of population ageing starts to get a hold, while, as Ugo Bardi points out in this post here, if oil stays over $100 in the longer run, then expansion may well become a thing of the past for Italian industry. Given that - with a debt to GDP level of around 105% - the Italian government now has to systematically reduce spending or risk credit downgrades with all that that would entail in the present climate, then quite simply it is hard to see where any growth at all is going to come from for the Italian economy in the years ahead. As we can see in the chart below, Italian GDP growth has been in trend decline for some time now, and certainly at this point trend growth cannot be much outside the 0% to 0.5% range (and it may even have turned negative in the eventually that oil stay high).



As can be seen in the chart, growth in the Italian economy has now lagged well below the eurozone average for more than a decade and growth is surely set to be the slowest in the euro region this year, even according to the latest European Commission forecast of a positive 0.1% issued on Sept. 10. The Italian employers group Confindustria - whose forecasts have been far and away the most realistic all this year - last week suggested the Italian economy would actually have a whole year contraction of 0.1 percent in 2008. If the prognosis is realised this will be the first annual contraction in the Italian economy in 15 years, and only the third annual recession since WWII (the others were in 1975 and 1993). In fact this is even worse than I was (I thought) pessimistically predicting at the start of this year (see my posts on my Italy blog), and in fact the outlook for next year would seem to be worse not better.

The Italian government has also cut its 2008 economic-growth forecast this week, but they continue to cling on to the hope that the economy may expand, however slightly, revising their outlook to a 0.1 percent increase this year, down from the 0.5 percent predicted on June 24.

The latest forecast was made public in just the same moment as Finance Minister Giulio Tremonti prepared to announce government spending for the proposed 2009 budget (which was submitted this week to the Italian Parliament for approval). Tremonti's three-year spending proposal, which represents an attempt to maintain the objective of balancing the budget by 2011, incorporates 10.4 billion euros ($15.3 billion) in cost cuts and savings for 2009. These saving rise to 17.2 billion euros in 2010 and 31.2 billion euros in 2011 in the hope that Italy will be able to balance the budget by that year. Tremonti has indicated that Italy's fiscal deficit will deteriorate slightly to 2.5 percent of GDP this year from 1.9 percent last year, but has asserted that in 2009, the budget shortfall will drop to 2.1 percent (although this is based on a government forecast of 0.5% GDP growth in 2009 which may well not be achieved).

Clearly this attempt to stay on course for a reduction in the level of Italian government debt is a laudable objective given the risk that any slippage will result in downgrading of Italian sovereign debt by the rating agencies, but it will be a very hard medicine for Italian citizens to swallow, since it will mean that the fiscal stance will be biased towards contraction at just the time when global credit conditions may remain tight and oil may stay over $100 in the mid term, in which case it is hard to see how negative growth in 2008 will not be followed by more of the same in 2009, and ditto in 2010. This at least is the big risk as I see it.

Germany


The German economy also suffers from congenitally weak internal demand (as I explain in some considerable detail here) and has thus become entirely dependent on exports, a characteristic which is doubly the case when you take into account that the 2011 balanced budget also means that there is very little in the way of expansionary fiscal support available to the German economy either. Like the Italian economy, the German economy contracted in the second quarter of 2008, but in the German case the q-o-q decline was especially dramatic, as can be seen in the chart below:




This is what it means to be totally export dependent, your headline GDP growth simply is very sensitive to any sudden sharp move in the rate of export growth. This is why most observers have been surprised by the severity of the German downswing, since they have simply not factored-in congenital export dependence (which is related to the age structure of the German population as far as I am concerned). For similar high median-age-related reasons German retail sales also seem to have peaked, in the German case in 2006 (see chart below) while the representatives of the construction industry have looked more like a set of dead men walking (or should I say following Eugen Leviné, dead men on leave) since the bursting of the last construction boom in 1995 . (I think a nice exam question for a 101 course in neo classical economics might be: the German and Spanish economies have had the same monetary policy applied since 2000, with differing outcomes for the respective housing sectors, explain).



As I said above, the final nail in the coffin for the most recent German expansion seems to have been hammered home by those Russian tanks going full throttle though the Roki tunnel, since Russia was really one of the last remaining areas of export expansion for German industry after all the others had steadily fallen down one by one (parodying Oscar Wilde, losing one of your customers might be thought to have been an accident, but losing all of them, one after another....). The big risk, as far as I can see is not simply that Russia ceases to be such an important source of German export demand, but that the slowdown in Russia also impacts on other countries who are close trading partners with Russia, such as the other economies in central and eastern Europe. Should this happen, and there are already signs that it is, then the impact will basically be a second shoe to drop for Germany, via the indirect route, since these countries are also important customers for German exports in their own right (especially the Czech Republic, Poland and Hungary).

German exports to Russia were up by 23 per cent in the first half of 2008 to €15.8bn ($22.5bn), according to the latest data from the German Federal Statistics Office. To put this in perspective, this is roughly 45% of the €36.8 billion euros worth of goods sent to the USA over the same period. It is not so much the volume as the rate of increase or decrease that matters, so while exports to the UK dropped 1.5% in H1 2008, while to the eurozone they were only up 3.9%, these Russian purchases were giving the much needed life blood to German industry.


Spain is Different

As always Spain's case differs from the other members of the "big four". Long the star pupil of the monetary policy classes being offered over in Frankfurt, Spain's stellar growth has now all of a sudden been transformed into its opposite. I have already gone into the background to all of this in two extensive posts on this site (here and here), so I will not burden you, dear reader, with more paraphenalia, beyond saying that Spain appears to be suffering from a systemic banking and financial structure crisis, and that the slowdown in the construction sector and the increase in unemployment is simply a surface reflection of this. This problem needs urgent attention (indeed it is possibly the most urgent item in the ECB in tray at the present time), but for our present purposes what matters is that the eurozone can in no way count on a growth contribution from Spain in 2009, in fact quite the contrary, we are more than likely going to see a Spanish GDP annual contraction, and possibly a quite substantial one.


France: Monsieur Average

Well, while the Spanish economy has long been the ECBs leading pupil, and the Italian one has been more like "l'enfant terrible", France has distinguished itself over the years by being, quite simply, extraordinarily ordinary. French GDP growth has excelled neither on the upside, nor on the downside in recent years, and in that sense France may be thought of as constituting something of a pole of potential stability during the current downturn (if Sarkozy and Trichet can put the knives away that is, and settle their differences in traditional gentlemanly fashion).



To be sure, the French economy needs structural reform, and the French system of public finances does need a huge overhaul, but, if we are more pragmatic than ideological, the fact that France is not under the same structural and demographic pressures to balance its budget by 2011, and the fact that France is running something of a trade deficit at a time when the other three big four economies badly need to export cannot be such a bad thing.

Indeed French President Nicolas Sarkozy's announcement today that he intends to shelve for the time being the deficit-reduction objective in the 2009 budget can be read as a move in that direction. The French budget is based on an economic growth forecast for this year and next of 1 percent, less than half the 2007 pace, and this seems fairly realistic, but it will leave France with less revenue and higher welfare costs than previously anticipated. Sarkozy intends to keep the budget shortfall at 2.7 percent of gross domestic product this year and next, which means that the French government won't be able to balance the budget in 2012, as previously pledged (France had already indicated a delay of one year over the norm). And all I can say is, more power to his elbow, since as I indicated above, I don't see this kind of decision as especially problematic, as long that is as the structural changes which are so necessary to guarantee sustainability in the longer term are implemented at the same time.


More Pragmatics Less Dogma

Well in this post I have attempted to argue a number of things. Firstly, the eurozone is now, in all likelihood, in its first recession. The bride can no longer wear white. But this had to happen one day or another, so it isn't exactly the end of the world. What we do now need to do though is face up to the reality of what is happening, and work to devise the policies which will help move our economies forward.

I am also arguing that this goal requires a recognition of that other reality, the de facto one of the existence of varying typologies across each of the individual big four eurozone economies, together with an acceptance of the inherent strength and weaknesses of each and every one of them, and the abandonment of the idea that they are all converging towards one common "ideal type", which they clearly aren't, except perhaps in that famous longer of longest terms mentioned by Keynes.

This recognition should open the door to the possibility of a rather more flexible policy, giving support where support is needed and not demanding uniformity simply for the sake of uniformity. Of course, I have long found myself being accused of being an idealist, and perhaps the vain hope that we could react flexibly and pragmatically to our common problems is just one more example of my "rotten to the core" idealism. Maybe it is, but I certainly hope not.

The Italian services sector purchasing managers' index also in fell in July, to a seasonally adjusted 45.6 in July from 48.5 in June. So the contraction continues, and even accelerates into the third quarter of the year.





And Italian retail sales declined in July for the 17th month in a row. The seasonally adjusted PMI for retail sales was at 38.2, up slightly from the 36.3 shocker registed in June.



Public Spending Cutback?

Earlier this week Italian Prime Minister Silvio Berlusconi survived a confidence vote in parliament over plans to raise taxes on oil companies and reduce salaries for mayors and public employees in a bid to balance the budget by 2011. Italy currently has a debt to GDP ratio of around 105% - way above the official EU limit of 60%. Italy is commited to at least achieving the common target of a balanced budget by 2011, but this looks to be fraught with difficulty to me, given Italy's very poor economic performance and all the negative headwinds going forward.

Berlusconi managed to clear this particular hurdle this time round without too much difficulty, since his allies in the lower house of parliament voted 312 to 239 to approve the necessary amendments to current legislation, and then passed the entire package 314 to 230.

The budget increases the corporate income-tax bracket for energy companies to 33 percent from 27.5 percent and raises taxes on oil and gas inventories. Banks and insurance companies also will pay more. Finance Minister Giulio Tremonti has called the measures ``Robin Hood'' taxes.

On the spending front, the government plans to cut city, town mayor and local administrator salaries by 20%. It is not clear how much of this is serious and how much "window dressing", but since the government estimates that budget cuts at ministries will generate savings of 9 billion euros ($13.9 billion) next year, the salaries of more than a few mayors and public dignataries must be involved.

The broader economic policy outlined in the budget aims at boosting revenue and cutting spending by 36 billion euros over the next three years. And even with these cuts the deficit is expected to widen to 2.5 percent of gross domestic product this year from 1.9 percent last year, largely as a result, of course, of the current recession.

Standard and Poor's however remain unconvinced, and say the budget measures will only have a "modest impact" on what is the world's third-largest national debt burden because the measures simply fail to confront the structural issues like pension spending and a bloated public administration.

``Italy's onerous general government debt and interest burdens will continue to constrain policy flexibility until there is sufficient political will to attack the heart of Italy's fiscal malaise,'' was the view of S&P's credit analyst Trevor Cullinan as expressed in a research note earlier this week.

Now, if, and despite all our reasonable doubts, the Italian government actually are serious about balancing the budget, and we will need to watch and wait to know since past performance is far from reassuring, then we are faced with the clear possibility going forward of seeing an Italy with negative GDP growth in full years 2008, 2009 and 2010. Since the little average underlying net growth that Italy manages to achieve these days will largely be undermined by cut backs in government spending and the impact of continuing high energy prices on headline GDP growth.




So the big question is: are the Italian people ready for three consecutive years of falling living standards and cuts in everything, or is Berlusconi going to have trouble holding his coalition together?