Jan. 27 (Bloomberg) -- Consumer prices in Venice are following the sinking city’s downward trajectory, and costume maker Stefano Nicolao says it’s just another symptom of the debilitating economic environment.
“The truly characteristic activities that defined Venice through the centuries have been absolutely flattened,” said Nicolao. “It’s war among poor people.”
Foreign competition, tax-evading rivals and inefficient public administration have hurt the artisans and manufacturers who helped build the lagoon city, he said. The 59-year-old businessman, whose clients include theaters in Tokyo and local masquerade parties, is feeling the price pressure himself in competitive bids to supply costumes to city-run stages.
As deflation anxiety grips peripheral Europe and requires attention from the European Central Bank, Italy stands out for the size of its public debt and the weakness of its economy. Before the euro’s introduction in 1999, the country relied on inflation to ease its debt and stimulate business activity. Now with entrepreneurs cutting prices to survive, Italy’s $2.8 trillion debt will exact a heavier cost on a struggling economy.
“It is much, much harder to deleverage in a deflationary environment,” said Georg Grodzki, head of credit research at Legal & General Investment Management in London. “That’s the big worry.”
Venice’s consumer price index fell 0.1 percent in December from the same month in 2012, making it the second major Italian city, after Palermo in October, to turn in a negative rate. CPI in Italy has fallen or remained the same in 14 of the last 15 months.
Italian 10-year bond yields rose 2 basis points to 3.93 percent at 9:47 a.m. in Rome after posting their first weekly increase in almost a month in the five days ended Jan. 24. That compares with yields of more than 7 percent in 2011.
Broader deflationary pressures from Greece to Portugal pushed the ECB into action in November with a cut to the benchmark interest rate. Core CPI, which excludes energy, food, alcohol and tobacco, fell in the euro-area to a record low of 0.7 percent the following month. On Jan. 15, International Monetary Fund Managing Director Christine Lagarde called deflation an “ogre” to be fought.
Some individual prices are somehow showing “negative rates,” ECB Governing Council member Ignazio Visco, also governor of the Bank of Italy, said Jan. 24 in a Bloomberg Television interview. “In the governing council of the ECB we are very, very attentive to that.”
Italy’s five-year break-even rate, a market guage of inflation expectations, has dropped to 0.87 percentage points from last year’s high of 1.53 percentage points in March, and is below the average of 1.27 percentage points in the previous five years. The rate is derived from a yield gap between nominal and index-linked bonds.
Japan’s five-year break-even rate is now 1.07 percentage points higher than that of Italy’s, the highest on record. As recently as April, it was lower than its Italian counterpart.
Italian businesses and households have been weakened by 13 years of chronic recessions and the austerity imposed in 2011 and 2012 by then-Premier Mario Monti. Tax increases and a two-year, 100 billion-euro ($137 billion) contraction in bank credit have taken money out of the economy. Firms that supply the public administration have been further squeezed by what Intrum Justitia, a credit management company, calculated as a European worst average of 170 days wait before receiving payment.
The fiscal challenges in Italy haven’t been offset by any significant improvements in the rules businesses follow as Monti and his successor, Prime Minister Enrico Letta, have mostly failed to liberalize the labor market.
Measures making it easier for companies to reduce staff have positioned Spain, which expanded 0.1 percent in the third quarter, for gains in productivity. These kinds of reforms can mitigate the damage from price declines, according to Joerg Kraemer, chief economist at Commerzbank AG.
“This is a kind of positive deflation,” Kraemer said in a telephone interview. “We have seen, with the exception of Italy, a huge decline in unit-labor costs, and this is now passed on partly to the consumers.”
Deflation, which is a drop in general price levels, makes products cheaper for consumers and pushes wages lower, damping spending and making it harder for governments to raise the money needed to pay down debt.
Inflation, conversely, tends to have a beneficial effect on tax revenue while fixed-rate obligations remain unchanged. Italy’s debt represents about 135 percent of its expected annual gross domestic product for 2013, a rate that has surged from 107 percent in 2008, and which the government has pledged to reduce starting this year.
“First, there is no debt sustainability math that adds up with deflation,” said Raffaella Tenconi, an economist at Bank of America Merrill Lynch in London. “Second, once you get it, it’s very hard to shake it off.”
Tenconi isn’t forecasting deflation and said that the recent CPI readings argue for an easing bias from the ECB.
The price declines in Venice, which appears to be subsiding at a rate of about 2 millimeters a year according to the Scripps Institution of Oceanography, come as shops along the canals are suffering from recession and an increase in foreign competition.
The total number of active entrepreneurs in Venice and the surrounding province fell 2.4 percent in the 12 months ended Sept. 30 to 111,345, even as Chinese-born entrepreneurs rose 6.5 percent to 1,449 and those born in Bangladesh advanced 16 percent to 714, according to the local chamber of commerce. The province of Venice has about 850,000 residents, including about 260,000 in the city.
“The risk is serious,” Roberto Perli, partner at Cornerstone Macro LP in Washington, said of deflation. “Italy is probably more exposed than other countries to deflation risk because of the broad economic situation.”
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