Rising inflation is serious

The expected steep rise in Greek consumer price inflation in January has been largely downplayed by everybody, including the market, because it is widely regarded as a blip. Even if this is the case, there are reasons to believe the Greek government should be vigilant about the future course of inflation projected by many economists to be the highest in the eurozone in the next few years. Headline inflation is expected to go up to 4.0 percent year-on-year in January from 3 percent in December, fueled by a rise in motor fuel and heating oil prices, adverse base effects and price increases linked to the introduction of euro notes and coins. Some economists, such as EFG Eurobank’s Plato Monokroussos, predict that headline inflation may spike to 4.2 percent or even higher in January, in what could be the highest inflation reading in the eurozone that month, but head south in the next few months toward 3 percent or lower in April-May. Monokroussos projects, however, that Greek core inflation, which excludes the prices of volatile fresh produce and gasoline, will rise sharply to 3.8-3.9 percent year-on-year in January from 3.3 percent in December. Many analysts, commentators and others in the market point to an expected rise in average consumer price inflation in the eurozone – Eurostat’s preliminary estimate put it at 2.5 percent in January – and quickly conclude that the spike in Greek inflation is compatible with price developments in the Economic and Monetary Union. They also emphasize that Greek inflation will fall sharply in the next few months, in line with the EU’s average inflation. This may be true to some extent, but some clarification is needed. First, it should be understood that Greek headline inflation as measured by the EU harmonized consumer price index will probably end up close to 4.5 percent or even 4.7 percent year-on-year in January, instead of 4 percent or 4.2 percent projected by the so-called national consumer price index. Since forecasts of actual EU or eurozone inflation data are calculated on the basis of the harmonized price index, the right thing to do is to compare Greece’s harmonized inflation figures with the eurozone’s harmonized figures. In doing so, one realizes that the inflation differential between Greece and the rest of the eurozone is wider that it appears, meaning a good segment of the country’s productive base is being gradually priced out of other EMU markets. Second, even if one agrees that Greek national or harmonized consumer price inflation will drop in February, aided by the delayed winter discounts in retail stores, the same holds true in the rest of the eurozone as well. Moreover, Greek inflation may ease less than expected in March, as some companies which had frozen their prices to facilitate consumers’ familiarization with euros mark up their prices to make up for the time lost. Assuming that headline inflation in other eurozone countries follows the downward path forecast by many international investment houses, the Greek economy may find itself in the unenviable position of experiencing a drop in inflation to 3 percent or a little lower by June, at a time when the average eurozone inflation may stand at 1.5 percent or lower. Merrill Lynch projects average EMU inflation to drop to around 1.0 percent by end-June. In other words, the inflation gap will have widened by then, hurting the country’s international competitiveness. To make things more difficult, wage negotiations in the private sector may help reignite inflation, especially if demands for a 6-percent pay rise by the main umbrella union organization (GSEE) and 7 percent by the bankers’ union (OTOE) are met. Although most analysts believe that common ground with employers will be found in the 4-percent area, economists such as SSB’s Miranda Xafa warn that the maximum wage increase the Greek economy can afford is 4 percent, including the catch-up clause in last year’s agreement. Xafa claims that higher pay increases will result in higher unit labor costs, worsening the economy’s competitiveness position demonstrated «in the highest unemployment rates within the EU» and the external sector’s negative contribution to growth. Even if we assume the wage increases to be agreed upon in collective bargaining will be mutually accepted and inflation-neutral, Greece faces the difficult task of closing a larger inflation gap with its EU partners in the months and perhaps years ahead, which threatens jobs and eats into the country’s long-term economic potential. Although most people seem to be resigned to the idea that Greece can live and prosper with such a large inflation gap, all interested parties should understand that EU inflows will not be around forever to propel the economy forward. So, they should try to tackle this problem together and as soon as possible, while general economic conditions are still favorable.