Strong euro and high labor costs are a double threat

Appreciation of single currency expected to rein in inflation

By Foo Yun Chee - Kathimerini English Edition

The euro’s continued appreciation in combination with rising labor costs could further erode the competitiveness of Greek products, even as it is expected to help bring down inflation, Alpha Bank has warned.

In its weekly economic report released on Tuesday, the bank said the strong single European currency has already weakened the competitiveness of Greek products vis-a-vis those produced by OECD member states.

Despite a deteriorating economic outlook for the eurozone, the euro has risen steadily, with the trade-weighted exchange rate gaining by 8 percent since April of this year. For this month alone, the euro has appreciated by more than 1.5 percent thus far on a trade-weighted basis.

The single currency’s unexpected strength came as the dollar continued to slide. Concerns over a war with Iraq and news that North Korea planned to boost its nuclear power capacity sent the dollar down yesterday to its lowest level against the euro in almost three years.

To avoid the threat to its competitiveness, Greece needs to keep a lid on unit labor costs, Alpha Bank said.

“If Greek unit labor costs increase by a higher percentage than in other OECD countries, it could mean a further loss of [Greece’s] competitiveness in 2003,” it warned.

The latest projections from the Bank of Greece, however, sound an ominous note. The central bank has predicted a 3.5-percent hike in unit labor costs this year, a near percentage point higher than the 2.6 percent estimated for the eurozone.

A firm euro means that salaries are worth more in terms of foreign currencies, Alpha Bank said in a pointed reminder to workers seeking pay increases in the coming year. It said the wage policy should take into account the strength of the currency.

On the positive side, the appreciation of the euro is expected to help bring down inflation which continues to overshoot the European Central Bank’s 2 percent price ceiling and the eurozone average by a large margin. Greek harmonized inflation in November came in at 3.9 percent, 1.7 percentage points higher than the eurozone’s 2.2 percent. Favorable base effects coming into play this month and early next year should put a brake on rising prices.

The strong single currency should lead to lower fuel prices which, in turn, is expected to result in lower imported inflation, Alpha Bank said. It said price developments in the coming months will also depend on the impact of a war in Iraq and the price of oil.

The firm euro is seen as not having a major impact on Greece’s balance of payments, which is influenced more by strong consumption. It would only be negatively affected if the government seeks to shore up flagging demand in the future with borrowing or foreign capital, Alpha Bank said.