BBVA's research unit revises its Spanish GDP growth forecasts for 2023 downward from 3.3% to 1.8% but keeps its estimate for 2022 unchanged at 4.1%. This reflects the scarcity of some raw materials and rising commodity prices generally, with the consequent increase in production costs already feeding through to inflation. In addition, the financial burden on businesses and families is expected to become heavier as the European Central Bank (ECB) moves forward with the withdrawal of quantitative easing. These trends are analyzed and discussed in the latest ‘Spain Economic Outlook’ report, presented by Jorge Sicilia, Director of BBVA Research and BBVA's Chief Economist, Rafael Doménech, Head of Economic Analysis, and Miguel Cardoso, Chief Economist for Spain.
Spain's GDP growth slowed during the first six months of 2022 compared to the second half of 2021. GDP advance in the first quarter of 2022 was +0.2% quarter-on-quarter and could have been +0.6% in the second quarter (according to BBVA Research estimates), considerably below the +2.6% and +2.2% QoQ in the third and fourth quarters of last year, respectively. Looking at the components of demand, the slowdown was seen across the board, although the fall in household consumption was especially sharp. However, the deceleration in the central period of the year will be less than expected three months ago, and this will partly offset some of the headwinds on the horizon. In addition, disruptions in global value chains continue to constrain the supply of certain goods, such as automobiles, where sales have declined by as much as 50% since 2019.
According to BBVA Research, household spending has been hit hard by the increase in the prices of raw materials and intermediate goods, particularly fuel and electricity. In addition, the likelihood of a gas shortage in Europe has risen, leading to constant revisions in the outlook for gas costs. The further upward revision in gas prices could subtract an additional 0.1 pp to 0.2 pp from GDP growth in 2023. Moreover, after a period of containment between 2020 and year-end 2021, there has been a greater pass-through of the increase in production costs to final prices, as businesses perceive that the rise in input costs will be longer-lasting than initially expected. As a result, inflation continues to surprise on the upside, and is no longer limited to a few CPI components. Core inflation, which encompasses 82% of the household basket of goods and services, could rise further to average almost 6% during the second half of the year.
On the other hand, households are not using the wealth amassed during the lockdown for consumption at the expected rate. As a percentage of disposable income, savings remain around their historical average. Uncertainty about the future course of the economy and rising inflation may prompt households to delay some decisions or even encourage investment in residential property as a safe haven.
In their report, the BBVA Research experts emphasize the low growth in productivity per worker. In recent months, Social Security enrollment has advanced at rates that on earlier occasions implied stronger GDP growth rates. This may directly reflect increased job creation in certain service sector activities, and the fact that unemployment is at its lowest level since September 2008. As a further factor, the effect of the labor reform, which has led to a higher percentage of “discontinuous” permanent contracts, may be keeping up job creation, albeit with a lower intensity of hours worked.
Despite the downward revision of expected GDP growth for 2023, the BBVA Research economists argue that, so far, the recovery is holding up, and the momentum remains positive for the third quarter of this year. They expect the slowdown in activity to be limited and short-lived, thanks to several factors. First, despite the risks surrounding the economy, the wealth accumulated during the lockdown could sustain consumption over the next few quarters. This would help to soften the impact of several of the headwinds described above or be used for home purchases. Secondly, effective release of Next Generation EU (NGEU) funds could accelerate over the next few quarters. Finally, the positive effects of the labor reform could help sustain consumption, particularly among the youngest generations, while favoring productivity. Hiring data suggest that the regulatory changes are reducing the weight of temporary employment, especially among under-25s. Enhanced job security could reduce precautionary savings among this cohort of workers or boost their willingness to take on debt. In addition, a more stable employment relationship could increase incentives to invest in the human capital of newly hired workers.
The main risk going forward is now inflation
BBVA Research forecasts that variations in the CPI will remain high, reaching almost 8% on average throughout 2022 and 3% in 2023. Even more worrying may be the trend in core inflation, which could reach 5% on average this year and 4% the following year. Several indicators show that the prices of most goods and services continue to rise or have stabilized at high levels. Future developments will depend on several factors in international markets, such as the impact of the invasion of Ukraine on commodity prices or whether supply chains continue to be disrupted. On the other hand, the effect of the performance of business margins, the outcome of collective bargaining and the impact of public policies will be decisive. Decisions are needed to help spread the costs fairly and prevent inflation from becoming entrenched, which would raise the risk of recession.
BBVA Research explains in its report that higher inflation expectations have impacted the outlook for interest rates. If forecasts come through, monetary policy rates in the US and the Eurozone could end the year 325 and 125 basis points above their year-end 2021 levels (at 350 bp and 125 bp, respectively). This could place a heavier financial burden on households and businesses, and thus restrict the funds available for consumption and investment. BBVA Research estimates point to a direct adverse impact of seven tenths and three tenths of a point on Spain's economic growth in 2022 and 2023, respectively. In addition, lower European demand will rein in the growth of exports and, therefore, of activity in the Spanish economy (-0.8 pp for the two years as a whole).
However, the 'Spain Economic Outlook' report points out that the rise in interest rates finds the Spanish economy better prepared than in previous recessionary periods. Household and corporate debt has fallen sharply in recent years and is now at levels similar to those of other Eurozone countries. Moreover, the private sector has amassed assets that can help soften the impact of a heavier financial burden. The situation of the public sector, which is loaded with debt, may be more vulnerable.
In their report, the BBVA Research analysts provide an initial assessment of the measures announced by the government in the last State of the Nation Debate, all of which were presented as transitory. Providing free public transport is a measure that will help lighten the burden of inflation and reduce the demand for energy; it is also more selective than the fuel subsidy. However, it seems an opportunity was missed to remove support for non-renewable energy consumption and use the released funds to bolster support for households, the self-employed and businesses, the sectors of the economy that are hardest hit by the rise in the price of gasoline and electricity. Regarding the announcement of taxes on specific industries, BBVA Research takes the view that it does not make sense to penalize specific sectors. The banking system, for instance, does not generate negative externalities in the rest of the economy, but rather the opposite: it helps allocate productive resources to the healthiest and fastest-growing industries.
Finally, BBVA Research points out that uncertainty surrounding economic policy will rise as next year's local and regional elections draw nearer. Spain still has a reform agenda to fulfill in order to retain access to NGEU funds and, probably, together with a long-term fiscal plan, to receive support from the ECB in the debt markets. The measures to reduce the impact of higher fuel and electricity prices may have to remain in place over time, moreover, as the cost of gasoline and gas is expected to remain high for at least the next year.