Bank of Spain warns that war in Ukraine will push up prices and shake recovery

It puts average inflation at 7.5% this year, almost 4 points higher than forecast

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Eurozone GDP grew by 2.2% in third quarter

MADRIDThe Spanish economy has not escaped the impact of the war in Ukraine. This was confirmed by the latest macroeconomic projections of the Bank of Spain published this Tuesday, which reduce GDP growth by one percentage point for both 2022 and 2023. Specifically, the Spanish economy will grow by 4.5% this year, while in December the Bank of Spain expected gross domestic product (GDP) to rebound by 5.4%. In 2023 it would be a timid 2.9%, one point less than the forecast 4 months ago, when a 3.9% growth was expected. The main reason behind this the rise in prices, especially energy prices. "We must be cautious", warn, however, sources at the Bank of Spain, who accept that the uncertainty about the evolution of the economy makes the elaboration of forecasts more complicated.

The downward revision, however, has not come as a surprise. At the end of February, the Bank's governor, Pablo Hernández de Cos, already warned that an escalation of the conflict in Ukraine would result in an increase of tension in the Eurozone's and, consequently, Spain's econnomies. "Russia's invasion of Ukraine constitutes a very severe economic disruption," the supervisory body summarises in the report. Therefore, although Spain does not depend so much on Russian gas and trade relations with Moscow beyond energy are less intense than for other Eurozone countries such as Germany, "it has not prevented cost increases, especially energy costs, to which the [Spanish] economy is particularly sensitive, from becoming more severe," the report states.

In addition, the report also notes the increase in the price of certain raw materials from Ukraine, such as cereals, as well as the impact of sanctions imposed on Russia by the West. All in all, growth in the first quarter is expected to be a timid 0.9%, which would be at lower levels than a year ago. Sources at the Bank of Spain point out, however, that this would be in a scenario in which the consequences of the war "do not leave structural after-effects".

However, the growth forecast for this year could be worse considering that the Bank of Spain estimated that in 2021 GDP would grow by 4.5%, after a downward correction of almost two percentage points following a revision of the National Institute of Statistics data. In the end, in the second year of the pandemic, the Spanish economy grew by 5%. This growth was due to the lower impact of the omicron variant – and, therefore, fewer restrictions being in place – on the economy compared to other covid-19 variants.

The positive note is the forecast for the year 2024. The Bank of Spain forecasts better-than-expected growth for the Spanish economy in two years' time and puts the GDP rebound at 2.5%, i.e. 0.7 percentage points higher than initially forecast (1.8%). Even so, the supervisory body points out that pre-pandemic levels could be recovered by the end of 2023, a quarter later than expected.

Soaring inflation

The escalation of both energy and fuel prices – the elements that have caused inflation to shoot up in recent months – since the war began has forced the Bank of Spain to be much more pessimistic about inflation, to the point that on average this 2022 it will shoot up 3.8 points more than forecast in December (3.7%). Now, the agency estimates that the increase in prices will stand at 7.5% on average this year. The Bank of Spain uses the futures market, characterised by its volatility, to make this forecast. It should be borne in mind that December's estimates did not include "the upward surprise" of prices in December (6.5% in Spain) and January (6.1%), as a result of higher energy and fuel prices, and that they have continued to grow, ending the month of March a CPI close to 10%.

The Bank of Spain estimates that inflation "will relax" as of July of this year, provided that the second-round effects continue to have little impact. That is to say, it has not detected that inflationary pressures are being transferred to wages which, for now, remain moderate and reflect increases well below inflation. A scenario, however, that has a full impact on the workers' purchasing power, according to the Bank of Spain. If this is maintained, the inflation rate would fall to 2% in 2023 and 1.6% in 2024.

This loss of purchasing power directly affects consumption, one of the engines of the economy, and therefore the evolution of GDP. The Bank of Spain estimates that although households have accumulated savings since the beginning of the pandemic, these are lower than expected in December. In addition, uncertainty about the evolution of the war is having an impact on household consumption, despite the fact that the rise in current prices does not allow workers to save up either.

The Bank of Spain has also made a first analysis of the Spanish government's measures to deal with the war. It hopes they can contribute to reduce inflation by between 0.5 and 0.8 percentage points.