The omens are not good for inflation in the Olympic year
The deterioration of Greek public finances has captured the attention of the general public and the media lately, overshadowing other problems, such as inflation. However, the bigger-than-expected increase in consumer price inflation in March, announced last week, new forecasts of higher oil prices this year, uncertainty over the new collective wage agreement and the prospect of unjustified price hikes linked to the Olympic Games should remind everybody that 2004 will not be better than 2003, further aggravating the international competitiveness of the Greek economy. The Greek CPI (consumer price index), national definition, surprised on the upside last month, rising to 2.7 percent year-on-year from 2.5 percent a month earlier. Market consensus wanted inflation to remain unchanged around 2.5 percent for a favorable comparison with last year’s spike in oil and fresh fruits and vegetables. In tandem, Greece’s EU-harmonized inflation rose to 2.9 percent from 2.6 percent in February, driving the country’s average harmonized inflation 1.3 percentage points above the EU-12 average inflation, according to EFG Eurobank’s chief economist Plato Monokroussos. The inflation differential, regarded by many as an important indicator of international competitiveness, stood at 1.0 percentage point in February. The inflation differential narrowed to 1.3 percentage points in 2003 from 1.6 points in 2002. Although wholesale price inflation, regarded by many as a leading indicator for consumer price inflation, fell to 1.4 percent year-on-year in February 2004 from 2.3 percent in January and 2.6 percent in February 2003, this development masked the strong favorable base effects in place. Wholesale prices picked up in February 2003 on the back of adverse weather conditions and oil price hikes as the markets sensed the approaching war in Iraq. The negative surprise in consumer price inflation in March forced some economists to revise upward their estimates for the entire year, as favorable base effects are expected to nearly disappear in the second half and average oil prices to remain at higher levels than initially envisaged. «Looking ahead, we expect the Greek national CPI rate to average around 3.0 percent year-on-year in the second quarter before moving to levels of 3.5 percent or higher during the second half,» said Monokroussos. It is known that inflation has been the Achilles’ heel of the Greek economy since the first oil shock back in 1973. Driven by its desire to be admitted into the eurozone, Greece managed to bring inflation down to average EU levels but has been unable to suppress it to the point it becomes irrelevant for competitiveness considerations. The superior economic growth rates experienced by the Greek economy during the last few years have undoubtedly contributed to the persisting inflation differential between Greece and the EU. Insufficient competition in a number of key output markets, such as transportation and energy, has done little to alleviate price pressures. Moreover, a rigid local labor market has underpinned comparatively higher unit labor costs, propping up inflation. On the other hand, the strengthening of the euro versus the dollar in the last 12 months has put a lid on imported inflation, therefore limiting its impact on headline inflation. As if all the above were not enough, Greece will have to contend with three other factors in its bid to check inflation: First, the world oil price forecasts, which lately have been revised upward. Second, the risk that generous wage increases given to public sector employees may spread to the private sector. Third, the likelihood that unjustified price increases occur ahead of the Olympic Games. Looking at the above factors, one can say that the odds that a new collective wage agreement in the private sector will satisfy both sides are not as good as they were the last time around. The main trade unions are controlled by the Socialist party and therefore have neither the incentive nor the party discipline to consent to a wage deal, providing much smaller benefits than earned by their counterparts in the public sector. In this context, it is easy to predict tougher negotiations but difficult to predict the outcome other than to say that the government should be very happy if any wage deal deviated little from expected inflation. As for the impact the coming Olympics will have on price developments, the situation is more encouraging. Although experience suggests that the risk of price hikes due to profiteering ahead of the Olympic Games is real, with such cases already cited in the tourist industry, consumer awareness along with the vigilance by the proper state authorities could help to limit the phenomenon. This does not mean it will disappear but its impact may be marginal. Oil price worries Things are no better on the oil front. A number of well-known foreign investment houses have added the level of oil (West Texas Intermediate) prices to the list of potential threats to macroeconomic stability. UBS, for example, recently revised its oil price forecasts to $32 per barrel on average for the year from $26 before. Although the appreciation of the euro against the dollar has helped mitigate the effect on inflation and output in eurozone countries, such as Greece, this has changed in the last few weeks. The price of oil in euros has been rising due to a combination of higher spot oil prices and the weakening of the euro vis-a-vis the dollar. This development is bad news for the economy of the eurozone as a whole and much more so for Greece, an oil importing country, which appears to be more sensitive than others to oil price increases. Indeed, a recent UBS study calculates the direct impact of the estimated rise of the average price of oil to $32 per barrel from $26 on Greek inflation to 0.79 percent of one percentage point versus 0.31 percent in Italy, 0.29 percent in France and 0.25 percent in Germany. All-in-all, the expected higher oil prices for the year, an uncertain new collective wage agreement, the likely price spikes linked to the Olympic Games as well as stimulative economic policies, such as the negative real interest rates, point to another high inflation year for Greece. This is not good news for a country trying to put its public finances in order and trailing badly in economic competitiveness.