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Spanish Economy and Its Effects on European Inflation

October 20, 2020 By Mircea Vasiu

One of the most affected economies during the coronavirus pandemic has been the Spanish one. The Southern European country registered a terrible decline in its most important industry – tourism.

With travel restrictions in place or changing from one week to another, it was difficult for travelers to plan their summer vacation accordingly. Moreover, it is not fun to go on a holiday wearing a mask – as masks are mandatory in Spain for several months now.

All in all, Spain depends on tourism – but so does European tourism. For decades, Europeans “invaded” the sunny Spanish coasts and the islands. The proximity, common currency, lack of borders – are only a few of the benefits for a European spending a holiday in Spain.

Inflation Calculation and the Impact of the Tourism Industry

The ECB (European Central Bank) has a mandate of price stability below, but close to 2%. The metric or benchmark for measuring inflation is the HICP (Harmonized Index of Consumer Prices). Moreover, the ECB favors the core HICP data, the one that discounts energy prices as they are too volatile. Therefore, what is left in the basket is made out of goods and services from other areas – like tourism, for example.

Accommodation services make up 2% of the HICP weight. Package holidays make up another 1.4%. Furthermore, transport by air, 0.9%, restaurants, bars, and cafes, 7.4%. Finally, recreational and sporting services make up another 1.1%.

By adding these categories together, we see the impact of the tourism industry on the inflation data. Or, with tourism inexistent over the summer, there was no upside pressure on prices. Just the opposite – economic agents dropped the prices, and the fight centered on how to get the customer at the lowest price possible. In economic terms, that leads to deflation, something that the data confirmed.

Last Friday, we saw the final HICP data for the month of September. Usually, there are no revisions on this final figure because the market is already priced in all the information and the final calculations rarely differ. Not this time!

Core inflation was revised even lower in September, from 0.24% to 0.22%. It shows the difficulty of creating inflation when the tourism industry accounts for so much in the index’s calculation.

The drama of the Spanish tourism sector, and of the Spanish GDP, will have traumatic effects on inflation further down the road. Coupled with the German VAT cut (albeit a temporary one), the Spanish tourism underperformance pressures the ECB to come up with even more easing.