Price falls in Spain revive deflation fears

Price falls in Spain revive deflation fears
By Mark Mulligan in Madrid
Copyright The Financial Times Limited 2010
Published: May 14 2010 13:04 | Last updated: May 14 2010 13:04
http://www.ft.com/cms/s/0/8caa382c-5f4c-11df-978c-00144feab49a.html


Core annual inflation in Spain fell for the first time since 1986 last month, reviving fears of a damaging deflationary trend in the crisis-hit country.

The country’s National Statistic Institute said on Friday that underlying inflation – which excludes volatile energy and fresh food prices – fell 0.1 per cent in April compared with the previous year and was down 3 percentage points from March. It said the biggest price falls were registered in processed foods and non-alcoholic beverages.

The data, which triggered a share sell-off across Europe and hit the euro, is bad news for a country that has just shown weak signs of crawling out of a recession that has lasted nearly two years.

The government, under pressure to slash a budget deficit of 11.2 per cent of gross domestic product, this week announced an average 5 per cent pay cut for civil servants, a move that could force prices down in other sectors.

Although lower prices boost purchasing power, constant disinflation encourages consumers to stop spending as they await further declines. At the same time, deflation also pushes up the real cost of debt for all sectors of the economy.

Spain, which has among the highest levels of household and corporate indebtedness in Europe, has for more than a year been identified by global economists as at risk from deflation.

The concerns were confirmed in March last year, when the country’s main consumer price index contracted 0.1 per cent year-on-year.

Economists and government officials at the time sought to play down the threat of deflation, blaming a sharp fall in energy costs and heavy discounting of consumer items such as clothes and shoes.

On Friday, José Manuel Campa, deputy finance minister, also shrugged off the significance of the drop in core prices in April, describing the data as a “one-off”.

Some economists, however, disagreed. Luigi Speranza, economist at BNP Paribas, told Reuters that “the general trend is down and we see core inflation negative until 2012”.

In Madrid, the Instituto Flores de Lemus, which tracks inflation closely, warned that the public sector salary cuts could consolidate the deflationary trend. As wage cuts took hold and spread to the private sector, prices could be driven down in services, it said.

It said Friday’s figure was 0.17 percentage points below its forecasts. It identified a sharp fall in the price of processed foods, especially dairy products, and some manufactured goods as the main causes.