The Bank of Spain has revised down its growth forecast for this year to 4.1% from the 4.5% it forecast in April. This is an increase in GDP that is still robust but that delays the moment of recovery from pre-Covid levels until the second half of 2023 and that coincides with the one that the OECD has just forecast this week. The reason for this reduction is that the first quarter of the year was much worse than expected, with a collapse in consumption due to the omicron variant, the carriers’ strike and the outbreak of the war in Ukraine, which has intensified inflation that is already was high and that it has eroded confidence.
That said, the institution detects that the tone of the economy has improved this spring. Services are pulling thanks to the end of restrictions. Confidence is soaring. And employment remains strong, although it has suffered somewhat in the branches most affected by bottlenecks, such as construction and manufacturing, and in those sectors that grew the most during the pandemic, such as health and education. In addition, the government’s measures are mitigating part of the escalation in energy costs. Even so, in the short term the war will continue to weigh down due to its impact on prices and on trading partners. And energy continues to have “a pronounced negative impact on purchasing power,” recall the economists of the supervisory body.
For the second quarter, the bank’s study service forecasts a quarterly GDP growth of 0.4% compared to the 0.3% recorded in the first. However, as the year progresses, he expects tourism, European funds and investment to provide further impetus. He also predicts that supply chains will be unblocked and that trust will be restored. All this should lead to a better end of the year with consumption recovering, supported by the savings accumulated during the pandemic.
Despite the gradual recovery that it envisions, the supervisory body highlights that uncertainty is still very high. All these assumptions rest on the fact that inflation gradually moderates, supply disruptions ease, and the impacts of the Ukraine war fade. As the report underlines, so far wages and business margins have shown some containment, for the time being removing the risk of an inflationary spiral, what in economic jargon is called second-round effects. Thus, according to the bank’s predictions, inflation harmonized with European criteria will be moderated this year by up to half a point due to the Iberian mechanism, standing at an average of 7.2%. And for next year it will drop to an average of 2.6%, six tenths more than in its April forecast. These forecasts on the CPI are based on the fact that “the transfer of costs to prices has already occurred” and that “wage demands will respond in a limited way to the inflationary rebound,” emphasizes the document published this Friday.
He knows in depth all the sides of the coin.
That is to say, the entity directed by Pablo Hernandez de Cos still sees the bottle as half full. But that does not mean that it does not warn of risks that are increasing. Three and a half months after the start of the war, “the uncertainty continues unabated,” he says. Global growth slowed by conflict. The bottlenecks persist with more reluctance than expected, in part due to the zero covid policy in China from which it is already emerging. Inflationary pressures have not subsided and have spread beyond energy and food to industrial goods and services, “limiting dynamism and dimming prospects,” he recalls. These price tensions have caused the withdrawal of monetary stimuli to accelerate. And although financing costs have remained at historically low levels, the bank considers that they could be expected to rise, “which could negatively affect agents’ spending capacity.” In the main scenario managed by the bank, this could lead to “some moderation in the pace of expansion.” But there are also other scenarios of higher risk: with more inflation and rate hikes, the most vulnerable companies and households could experience greater difficulties in paying their debts. Even in a context of tightening monetary policy and investors’ concern about growth, “episodes of financial turmoil cannot be ruled out,” he concludes by way of warning. The Bank of Spain does not hide any of the threats that the Spanish economy may face in the near future.
The entity is particularly concerned that consumers and markets believe that inflation will be somewhat higher. In his opinion, although the CPI will continue at high rates for several months, it should lose steam once the new cap on the price of gas in the electricity market is implemented and as supply problems are resolved. It should also slow down if you look at futures contracts in the commodity markets, those that are signed to lock in a price in the future. The Government’s fiscal measures on the price of electricity and fuel reductions are already helping to slow down energy prices. And the bank’s calculations suggest that the so-called Iberian mechanism approved this Thursday to limit the cost of gas would cause a sharp slowdown in the energy component: it would go from having grown 46% in the first quarter to negative rates as of the fall of 2023.
However, there are still elements that are pushing to the upside and that could pose a risk of becoming entrenched. Food prices and the core index, the one that excludes energy and unprocessed food, are rising more than expected. The war in Ukraine and the zero covid policy in China have intensified supply problems and, therefore, will continue to push inflation up. Companies have also been partially transferring the cost increases they suffer to their sales prices. There is a fairly vigorous rebound in services that suffered from the pandemic and are now raising their prices. And the recovery in demand at the end of the year will limit the slowdown to some extent. But the biggest risk of all is that the unexpected persistence of inflation will cause companies to continue raising prices and workers to raise their wage demands. At the moment, moderate wage increases are being signed in collective bargaining and entail losses in purchasing power. For their part, business margins are still below pre-pandemic levels and show less dynamism than in the rest of Europe. However, such behavior could change in the face of contagion from inflation for all products. If this happens, competitiveness could be lost, trigger inflation and have less activity and employment, warns the supervisor. The Bank of Spain has been explaining for some time that the current outbreak of inflation supposes a loss of national income due to the increase in the cost of raw materials that would have to be distributed between companies and workers,
Despite the growth of the economy, the unemployment rate will fall very slightly from 13% throughout the projection horizon until 2024. And there is some uncertainty about the degree of execution of European funds, says the bank, which could delay an investment business that is already suffering from war and bottlenecks.
On the other hand, the public accounts deficit will drop considerably this year to 4.6% of GDP from the 6.87% computed at the end of last year. Largely due to the robust behavior of income. But starting next year, unless action is taken, it will stop falling and remain stuck around 4%, which may represent another risk in a tightening environment.
Finally, the Bank of Spain warns that this forecasting exercise closed with figures as of May 24. But in subsequent data, inflation remains somewhat higher than expected. On the other hand, the extension of the Government’s measures until September will help to slightly improve GDP and inflation. Instead, the new embargo on Russian oil could subtract some growth: less than in other European countries and there is still time until 2023 to prepare, the supervisor stresses.