If strong GDP growth is widely regarded as the strong point of the Greek economy during a period of poor economic performance worldwide, relatively high inflation continues to be its Achilles’ heel, undermining its international competitiveness and future growth prospects. Although Greek inflation is still expected to outpace average EU inflation next year, there are good reasons to believe it will decline considerably in 2003, somewhat closing the inflation gap with the rest of the EU. Greek consumer price inflation, measured by the national CPI (consumer price index), surprised on the upside in August, coming out at 3.5 percent year-on-year. That was higher than the 3.3-percent year-on-year figure recorded in July and above the market’s consensus estimate of 3.3-3.4 percent. Perhaps worse than that, Greece’s EU harmonized inflation picked up to 3.8 percent year-on-year in August from 3.6 percent in July, a little less than double the eurozone’s annual inflation, which rose to 2.1 percent in August from 1.9 percent in July. EU15 annual inflation rose to 1.9 percent in August from 1.8 in the previous month. In August, Greece ranked third behind Ireland and the Netherlands among the EU countries, with the highest 12-month inflation averages with 3.8 percent versus 4.5 percent for Ireland and 4.4 percent for the Netherlands. Persistently high oil as well as fresh produce prices due to adverse weather conditions in early September have dampened hopes for a sizable drop in Greek inflation, measured by the national CPI, to around 3.2 percent year-on-year in September. Taking the new realities into account, analysts have already revised upward their projections for the month to 3.4-3.5 percent, showing price stickiness despite a couple of boycotts of retailers organized by consumer groups. This, along with expected higher inflation readings in October and November due to unfavorable base effects, have produced forecasts for a 3.5-3.6 percent average inflation this year, well above the eurozone’s average inflation, projected by various organizations between 1.8 and 2.1 percent in 2002. Yet, things look a lot better on the inflation front for next year. First of all, the impact from the physical introduction of euro coins and notes this year will not be there in the first few months of 2003, making year-on-year comparisons more favorable. Indeed, Greek inflation picked up in January, partly due to the rounding off in prices related to the introduction of the euro. However, the second-round effects on inflation from the introduction of the single European currency, taking place between April and June, turned out to be equally strong, keeping inflation at high levels as many businesses that had been bounded by gentlemen’s agreements not to increase prices in the first three months of 2002 rushed to mark up prices in order to restore profit margins. It is now estimated that price roundoffs and other euro-related increases contributed to inflation by more than 1 percentage point. This effect will obviously be absent next year, therefore helping drive Greek inflation lower. Moreover, it seems as if Greece is among the EU countries most adversely affected by the introduction of euro coins and notes. This means that this year’s euro-specific inflation gap should normally close in 2003. Needless to say, price comparisons for a variety of goods between Greece and wealthier EU countries should be expected to intensify, helping put a lid on excessive price increases. Economists point out that adverse weather conditions have also played a key role in pushing Greek inflation higher both this year and last year. Indeed, prices of fresh fruit and vegetables have, on average, exceeded 30 percent cumulatively in 2001 and 2002. In addition to affecting demand for these products, these price hikes have also alerted government officials, who seem to be more willing to use cheaper imports to combat inflation more effectively. Moreover, if one assumes a return to more normal weather, fresh produce price comparisons with this year should be much more favorable in 2003. This should also help push inflation lower and close somewhat the inflation gap with the rest of the EU next year. Another factor which should be expected to contribute to the deceleration of Greek inflation next year is unit labor costs. Greek unit labor cost growth is expected to outpace average EU growth rate in 2002, rising by 3.1 percent versus an expected 2 percent in the EU, but ease to a similar 2-percent growth rate next year. Given the importance of unit labor costs in determining the prices of some non-tradable goods and services in Greece, this too should act as a damper on inflation. It looks as if the secondary effects of high oil prices on inflation are stronger in some EU countries such as Greece. Assuming that the average oil price in 2003 is similar to the one in 2002 and that the euro holds its ground against the US dollar, Greek inflation should be among the biggest beneficiaries in the EU. Though there is much uncertainty about some of the assumptions used above to predict the behavior of Greek inflation next year, there appears to be ground for hope. But this is not to suggest that efforts to liberalize input and product markets should be abandoned, fiscal policy should be further relaxed, or the role of expectations in determining inflation should be downplayed. Rather, a more favorable environment to bring down inflation should be exploited to the full.