EconomicsInflation Can End Up Hitting The Economic Recovery

Inflation Can End Up Hitting The Economic Recovery

The Bank of Spain continues to defend the official message from the ECB that inflation will moderate in the coming months, but admits in a recent report that there are indirect and second-round effects that may make it more persistent than initially expected. An uncontrolled rise in prices affects, in the short term, the disposable income of households, the cost of production of companies, expectations of consumption and investment, and almost in the first place, the ECB’s interest rate policy.

The Bank of Spain already admits risks in which the inflation episode may be more persistent than expected , although the body continues to hold on to the ECB’s official message of “temporary” . In a preview of the quarterly forecasts of the Spanish economy, which will be published on Tuesday of the following week, the institution’s economists analyze in a study, The factors behind the recent increase in inflation in Spain , the evolution of the CPI and the factors that can influence it.

Experts Matías Pacce and Isabel Sánchez trust that the price increase is “transitory” and foresee that it will moderate in the coming quarters , but they admit certain risks that would increase “the degree of persistence of the current inflationary episode.” In particular, they point out that “it cannot be ruled out that the price increases that have been registered in recent months will end up generating additional increases, and possibly more lasting ones, through indirect and second-round effects.”

The document admits that the rise in energy prices, especially electricity , is exceeding the forecasts of economic agents. The Bank of Spain points out that the increase in electricity prices is being one of the main factors that would have conditioned the recent evolution of inflation in Spain.

This increase would have been associated with the rise in price, fundamentally of gas, in turn, linked to some “specific distortions” in supply and with greater demand from Asia, and, to a lesser extent, of CO2 emission rights, such as a consequence of greater ambition in the greenhouse gas emission reduction targets in the European Union since December 2020.

“There may still be additional hikes due to indirect and second-round effects”

Everything indicates that high gas prices will last until the first quarter of 2022, or at least that is what the electricity sector handles . The Bank of Spain report makes it clear in its report that if “the recent rise in electricity prices, especially if it proves persistent, will end up affecting the prices of those goods and services that are produced by companies that use this factor more intensively “.

The report highlights the factors that explain the significant increase in the price of gas between April and September. And it highlights how some producing countries have problems maintaining some infrastructures. Norway, the second largest gas supplier to Europe, has put many facilities under review this year . Its main company, Equinor, which extracts the largest amount of gas in the country, has warned that prices will remain high throughout the winter, but there are also risks of lack of supply if prices continue to rise.

The level of storage of this hydrocarbon remains at low levels in Europe , after the reduction observed by the harshness of last winter, the experts from the Bank of Spain recall.

The industry is the main affected in this price escalation. Fertilizer manufacturers in Europe have already begun to paralyze production in the face of rising gas prices. In general, the entire industry needs intensive use of energy, also some activities in the service sector, such as transport. The Bank of Spain recalls that since the end of 2020 there have been some significant bottlenecks in global supply chains that would have limited the capacity of companies, especially in manufacturing.

The PMI survey of the sector has been recording for months record after record in the prices charged by the suppliers of the factories , as well as in the sale prices of the finished products. The economists of the Bank of Spain speak of an increase in the price of intermediate goods, because the strong demand caused by the reopening of the economies is overflowing a limited production capacity of the factories.

“The acceleration of industrial production prices in Spain, with special intensity in the branches of metallurgy, basic chemistry and the paper industry; they have not yet been reflected in an appreciable way in the evolution of the prices of the consumer basket “, the two economists warn.

A recent ECB study indicates that the transfer to consumer prices, to the end customer, takes between 12 and 18 months in non-energy industrial goods and its impact is limited . “But it is possible that the frictions that have been observed so far in global supply chains could end up being more persistent than anticipated,” they admit. For some industries such as automobiles, the chip supply problem will take time to resolve.

Economists also, in their analysis, warn of the dreaded second-round effects . The CPI is used in the street economy to adjust salaries, pensions or rental income. A persistent rise in inflation ends up being transferred to these aspects of daily life, which ends up causing greater inflationary pressure on prices.

“In the short term, the intensity of these second-round effects could be relatively limited by the small number of agreements with safeguard clauses in Spain due to inflation,” they explain. But the experts at the Bank of Spain do not minimize the impact it has on consumer sentiment and expectations. Rising inflation is a brake on consumption, families tend to save to wait for a drop in prices.

An inflation rising moderately is good for the economy , indicates that demand works good pace, but if it is too high causes mismatches ends up affecting growth. The Bank of Spain recalls that it is a key indicator in monetary policy. If inflation rushes out of control, the ECB will have no choice but to intervene to contain prices . And this perspective not only scares families and their consumption, but also companies that reduce their investment and spending by anticipating lower sales and more expensive loans.

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