Inflation Is Simmering Again

After four years of improvement, inflation once again clouds the outlook in Italy. A growing economy, higher taxes, and a slumping currency have fueled worries that inflation in 1995 will top 5% for the first time since 1991.

Clearly, the export-led recovery remains in place. Although the real gross domestic product was flat in 1994's fourth quarter compared with the third, for the year the economy grew 2.2%, after dropping 0.7% in 1993.

Exports rose a strong 10.3% in the year ended in the fourth quarter. The data for 1995 look promising also: January and February exports shipped outside of the European Union are up 20.3% from a year ago. Italy's industry is benefiting: Production rose 0.5% in February, to stand 7.6% above year-ago levels. Exports should lead the healthy 3% GDP growth expected in 1995.

Consumer spending is where the Italian economy needs a boost. Spending grew only 1.6% in 1994, less than expected. Weak wage growth and increased taxes are squeezing incomes. Plus, unemployment remains high, especially in the impoverished south.

With the economy on the mend, however, inflation is picking up. Consumer prices in March jumped 4.9% from a year ago, the fastest pace in almost 21/2 years (chart). Rome's National Institute of Statistics said indirect taxes initiated back in 1992 added to the broad increase in prices last month, and it forecast that new taxes passed in February could add an additional 0.72% to the 1995 rate of inflation.

The lira will also exert price pressures. The currency has fallen 16% against the mark since Jan. 1. In response, the Bank of Italy lifted official short-term rates by three-quarters of a percentage point on Feb. 20. Since then, it has nudged up market rates further, leading Italian banks to raise their prime rate on Apr. 13, to 10.75% from 10%. However, higher taxes and a falling currency are a volatile mix that can only hurt the inflation outlook and lead to even more rate hikes in 1995.

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