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Inflation will not be negative but will be restrained

  The average inflation for consumer prices in 2009 will be negative for the first time in the last few decades, compared with the 4.1% average of last year. But this average obscures the marked fluctuation occurring throughout 2009. The slowdown in prices started in August 2008 continued during the early part of 2009, up to the biggest year-on-year drop in consumer prices of recent decades, namely 1.4% in July 2009. But from then on there was an upswing so that, in November, year-on-year inflation returned to positive figures at 0.3%. Will it also be negative in 2010? No, as discussed in the rest of the box, but it will remain at a low level.

  The ups and downs of the inflation rate have been strongly affected by the trends in the energy component, which closely mirrors variations in oil prices. After a record high of 147 dollars per barrel in July 2008, the price of crude slumped to 37 dollars in December of the same year, but since then has tended to pick up again, going above 70 dollars per barrel in November and December 2009. It's reasonable to predict a rise in the price of this black gold in 2010 due to the surge in the world economy. However, this recovery will probably be gradual and, given the worldwide surplus capacity in crude production, we don't expect any sharp rises in oil prices. Overall, energy prices will probably boost the general consumer price index.

  But energy isn't the only component that introduces an element of uncertainty into the inflation trends for 2010, as unprocessed food prices are also a highly volatile component, being strongly affected by international commodity markets. With the information currently available, it seems that these prices will continue to recover, albeit moderately.

  And what's happening with the more stable core of prices, also known as underlying inflation, which excludes unprocessed foods and energy products? Throughout 2009 this has gradually fallen to close to 0% in September and October, forced down by the squeeze on family consumption. However, in November it picked up to 0.2% and might have bottomed out with the slight improvement in the economic situation. In 2010 it will probably recover slightly.

  Another element to take into account in price trends for 2010 is the expected rise in value added tax as from July. An increase of 2 points from 16% to 18% in the general rate and of one point in the reduced rate, from 7% to 8%, represents a theoretical increase in inflation for consumer prices of 1.2 points, if these rises are passed on to prices in their entirety. However, this is not likely to happen given the weakness of demand, so the effect will probably only be half this figure, the rest being absorbed by smaller business margins.

  From the point of view of costs, competitive pressure in an environment of decreasing consumption has led to the diminished business margins, as many companies have decided to cut prices to stop their sales from falling. Salary statistics also show a slowdown, although this is very slight considering the extent of the recession and rising unemployment. So what will happen in 2010? The weak economy will continue to restrain companies' margins, while salaries will probably slow up, especially taking into account the fact that they will be based on a lower past inflation rate.

  Consequently, more moderate costs, together with improved productivity, might mean that the inflation differential with the euro area, Spain's main trading partner, will not deteriorate noticeably. This differential has been favourable for the Spanish economy since December 2008, representing a gain in price competitiveness. However, after a record 0.9 percentage points in May, this differential has tended to shrink.

  In conclusion, although prices have picked up since July 2009 and will probably end the year at around 1%, competitive pressure in international markets within a context of globalization and surplus industrial capacity, and also the slight improvement in the economy, will keep inflation restrained. Consequently, and as part of the adjustment in the Spanish economy, prices will continue to reflect the weakness in demand and inflation will continue at low levels, although the trends in commodity prices are somewhat uncertain.

  This box was prepared by Pere Miret

  European Unit, "la Caixa" Research Department

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