Research Dept. News
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Monthly Report, num 354 - February 2012
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Spain: overall analysis - Prices
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Inflation falls and the outlook darkens
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Inflation falls by 5 tenths of a percentage point to 2.4%.
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December served up what had been promised. The year-on-year rate for the consumer price index (CPI) fell by 5 tenths of a percentage point compared with November, placing its year-on-year change at 2.4%. This increase masks the change in trend undergone by prices in April after reaching a peak with a 3.8% year-on-year change and their practically unabated drop since then. The extent of this fall will be determined both by the severity of aggregate demand's lethargy and also the performance of energy products.
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In spite of the squeeze in activity in the fourth quarter, indicated by the Bank of Spain, the explanation for December's fall in inflation does not lie so much in the recessionary tone of consumption but rather in the disappearance of last year's base effects. In December 2010, inflation rose by 7 tenths of a percentage point due essentially to rises in the price of tobacco and fuels and oils. On the other hand, this year tobacco has remained stable over the last three months and fuels and oils even decreased slightly in December. These effects have caused the year-on-year rate of change for tobacco and fuels and oils to alternate from 13.6% and 14.0% in November to 4.9% and 8.6% in December.
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International tensions push up oil prices.
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In fact, the performance of fuels and oils is precisely one of the unknown factors for this year. The geopolitical tensions generated regarding the Strait of Hormuz, a marine corridor of just 60 kilometres at its narrowest point through which approximately 40% of the world's crude travels, has helped to momentarily push up oil prices in January. Oil products constitute 54% of final energy consumption and Spain imports 98% of these so, in this case, our country is totally dependent on others. Any distortion in the trade of fuels and oils will have an immediate effect on prices and therefore on the CPI, of which it accounts for 7.7%.
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In fact, this dispute is already having an impact on energy supply policy via European sanctions, which will force a reorientation regarding Iranian crude imports. This country is the largest supplier for Spain, contributing 15% of the total. It is unknown whether this lower supply will push up fuel prices.
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The euro's depreciation makes imports more expensive.
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Another factor increasing the risk of higher oil prices is the appreciation of the dollar. Given that barrels of Brent quality oil are traded in dollars, the more the euro depreciates against the dollar, the more expensive it is to buy. A rise in price in this commodity is then passed on to the economy as a whole, pushing up inflation. This is a common phenomenon throughout all euro area countries.
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If we compare the price of fuels in Spain, not including taxation, with our largest trading partner, namely the euro area, they are above the average, according to the latest report on this area by the Ministry of Industry. However, if we include taxation, petrol and diesel are 14% and 7% below the average for the 17 countries that share the euro. Even so, Spain's taxes add more than 40% to the final price.
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This high level duty can be explained by the difficulty in replacing oil with another kind of input. This phenomenon makes fuel prices inelastic and means that, when they rise, there is less variation in the amount consumed. As a result, autonomous communities have used fuels to impose the so-called «health cent». This duty on the price of petrol and diesel is passed on almost entirely to consumers. That's why a large proportion of the differences between prices in the different autonomous communities were in the region of 3.7 and 4.2 cents per litre, respectively, in November.
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Inflation will fall towards 1.4% but there are risks that might push it up.
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In spite of the aforementioned risk of prices rising, the slump in activity will become a decisive factor in pushing inflation down. The measures adopted to reduce the deficit will have a notable effect on aggregate demand and, according to our forecasts, will reduce growth prospects for 2012, placing the fall in GDP at 0.5% year-on-year. For this reason, our inflation forecast for 2012 is around 1.4%. The extension of the extra low VAT rate and a return to tax deductions for a primary residence will hardly have any effect on the CPI.
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This core scenario assumes an average price of Brent quality oil for the whole of the year at around 104 dollars; i.e. reflecting a context where the problems in the Persian Gulf are contained. These forecasts also assume a dollar-euro exchange rate above 1.30 for the year as a whole. Any deviation from these two assumptions will push up inflation in 2012. Moreover, our forecasts do not include any modifications in indirect taxation that might occur, which would also increase the inflation forecast. In short, the downward slide will continue in 2012, although the euro's devaluation and oil prices might lessen its fall.
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