The Bank of Spain warns of higher than expected inflation in 2023 and 2024 and lowers the GDP forecast for next year

The fight to appease the price increases that have been suffocating families and companies for almost two years will be longer than expected. The significant increase in energy prices during the summer – especially oil, with a barrel of Brent 28% more expensive than before the holidays – has led the Bank of Spain to revise upwards its inflation forecasts for 2023 and 2024. Furthermore, the banking supervisor warns that the slowdown in the European economy, high interest rates and the rise in energy prices will hamper Spain's economic growth next year.

The macroeconomic forecasts that the banking supervisor published this Tuesday indicate that 2023 will close with an increase in consumer prices of 3.6% on average—four tenths more than what was expected until now—. A new omen that responds to the increase observed in energy prices in recent months.

These new inflationary pressures on energy – with a special role for fuel – will also extend to next year, when the energy support measures adopted by the Government since 2021 are expected to decline.. These two factors, added to the base effect – fuel inflation was drastically reduced at the end of 2022, so, when comparing the coming months, the rates will be higher – suggest that there will be a rebound in general inflation until mid-2024. To the point that the inflation forecast for 2024 is revised to 4.3%—seven tenths more than in the previous analysis.

We will have to wait until 2025 for inflation to fall below the 2% that the European Central Bank (ECB) sets as its objective. In that year, the Bank of Spain expects the increase in consumer prices to be 1.7%.

Regarding the expected growth, the Bank of Spain maintains its forecast and is betting that the GDP will grow by 2.3%, in the same line as indicated by the majority of analysts and the acting Government itself.. A figure that, however, does not take into account the review of the 2021 and 2022 GDP data that the INE undertook on Monday and that the Bank of Spain has not incorporated into its analysis.

However, signs of slowdown coming from different parts of the world and the rebound in energy prices have led to a downward revision of the forecasts for 2024.. The supervisor believes that GDP will grow by 1.8% next year—four tenths less than what was forecast before the summer.

The Bank of Spain predicts that the economy will slow down in the second half of this year. The supervisor expects GDP to advance 0.3% in the third quarter, a figure lower than that recorded in the first (0.5%) and second (0.4%). For the fourth quarter, activity is expected to be weak as a result of the drop in exports and the effect of interest rate increases, which will continue to impact households and companies.

The slowdown in the second half of the year is one of the main reasons why the 2024 GDP is revised downwards. Although it may seem unintuitive, this is because the economic growth that occurs during those months has more effect on the GDP of the following year than on the current one, due to what is known as the statistical 'carry-over effect'.

The economy would gain momentum again in the first quarter of 2024, thanks to a certain recovery in exports and the reduction in inflation, which will be accentuated especially from the second half of the year and will allow the recovery of part of the purchasing power lost to Workers. The deployment of European recovery funds will also contribute.

However, the economy will have to face several fronts that will weaken growth and about which there is uncertainty. First of all, there are interest rates, which will remain very high compared to historical standards also in 2024. Then there is the withdrawal of energy support measures, which will raise energy prices with the consequent impact it will have on homes and businesses.. And, in addition, it must be taken into account that tourism, which has been an important driver of growth this year, will moderate after having already fully recovered this year.

As always happens with forecasts, the scenarios proposed are subject to risks, in this case with special prominence of the impact of rate increases. The Bank of Spain recognizes that there are difficulties in calibrating the impact that strong increases in interest rates will have on the economy. If rate hikes hit harder than expected, the economy could show more weakness and inflation could fall faster. The Bank of Spain admits that, in this context, “it is particularly difficult to determine what is the appropriate dose of monetary restriction.”