Bad weather and oil look like driving CPI up again

If pundits and some analysts are right, then Greek consumer price inflation will head back up in February and may even approach the 3.7 to 4.0 percent area on the back of rising oil and fresh produce prices. Although inflation is still forecast to ease this year, closing somewhat the gap separating it from the Eurozone average, the prospects for a sharper and permanent decline are not as visible as a few months ago. This can be attributed to a combination of factors, namely rigid high oil prices and approaching general national elections, making tough decisions on enhancing competition in key output and input markets less likely and budget expenditure cuts almost impossible. Since the first oil shock back in 1973, inflation has been the Greek economy’s Achilles’ heel, undermining its international competitiveness. Although Greece succeeded in bringing down inflation to single low digits and satisfying the price stability criteria for joining the EMU at the start of 2001, it has failed to close the inflation differential with the majority of its EU and eurozone partners. Greek national and EU harmonized inflation averaged 3.6 percent and 3.9 percent respectively in 2002, much higher than the average eurozone harmonized inflation of 2.6 percent in the same year. Greece’s higher inflation rate can be partly explained by its strong GDP growth rate which has exceeded the estimated potential GDP growth rate compatible with non-inflationary economic expansion. This has given rise to the so-called positive output gap, exerting upward pressure on inflation at a time most other eurozone countries are running negative output gaps. It is not a coincidence that Greek economic growth has outpaced the average EU GDP growth rate since 1996. According to preliminary figures provided by the National Statistics Service, the Greek economy grew by 4 percent, surpassing even the government’s target of 3.8 percent growth. Although Greek national headline inflation fell to 3.1 percent year-on-year in January from 3.4 percent in December 2002, on the back of favorable base effects as bad weather conditions and the introduction of euro coins and notes had an adverse effect on inflation in January 2002, core inflation did climb. According to EFG Eurobank’s calculations, core consumer price inflation, which excludes volatile fresh produce and fuel and is widely regarded as a better gauge of underlying inflationary pressures, rose to 3.7 percent year-on-year in January from 3.5 percent in December 2002. Moreover, the combination of bad weather and high oil prices in February threaten to drive inflation back up to the 3.7- to 4.0-percent zone, rendering the official optimistic budget assumption of 2.5-percent average inflation this year unfeasible just two months into the year. Bad weather is expected to push the prices of fresh fruits and vegetables higher in February, whereas the persistent high oil prices continue to put more pressure on prices. Weather may not be predictable, oil is, however, more predictable and the latest message from the oil market is not at all encouraging. Merrill Lynch (ML) raised its 2003 oil price forecast just last Friday, claiming that fundamentals and not the prospect of war in Iraq justified a higher average oil price this year. ML said its new oil (brent) price forecast of an average price of $26.50 per barrel versus $22.50 earlier was based on an estimate of a very large global OECD inventory deficit in the order of 123 million barrels, the largest since the very tight levels of 2000. Although ML past estimates show that the direct effect of a $10 oil price hike on Greek inflation is just 0.5 percentage points – the same as in Italy, Austria and Finland – past experience shows that the indirect effects of higher oil prices on Greek inflation are relatively strong and last longer. Although the stronger euro has mitigated some of those effects this time around, few doubt that higher oil prices will find their way to final consumer prices, with the service sector which is not that open to international competition leading the charge. On a positive note, growth in unit labor costs, a key component of production costs in the non-tradable sectors, is expected to decelerate to 2.0-2.5 percent in 2003 from an estimated 3.0-3.5 percent last year, but still outpace the eurozone average. In addition to all this, one cannot rule out the relaxation of economic policy this year and perhaps next as general national elections draw closer, in keeping with the traditional Greek political approach. Although general elections are scheduled for the spring of 2004, no one can exclude the possibility that they be held in the fall of 2003. Businessmen and analysts alike are concerned about the impact of a prolonged election campaign and would like it to be short. Nevertheless, with the ruling socialist party behind in the polls, the prospects of calling early elections are not high at this point. A number of analysts think that should the current gap in the polls – favoring the conservatives – persist, chances are the next general elections will be held in 2004. If that’s the case at end June, when Greece’s term as EU president ends, then a prolonged election campaign will most likely become a reality and economic policy will become de facto, more stimulative and, therefore, more inflationary. Although favorable base effects, especially in the period April to June, and again in September, still argue for a further decline in Greek inflation this year, it becomes increasingly clear that the drop will not be as big as estimated and hoped for a few months ago. Higher oil prices and, more importantly, the beginning of a prolonged election campaign, almost always characterized by pro-inflationary fiscal policies, constitute the highest hurdles to bringing Greek inflation down permanently to average eurozone levels. Unfortunately, painful policy measures aimed at enhancing competition in key output and input markets are not part of any election campaign.