Inflation Prospects in Spain

As the geopolitical disturbance is in a multiyear high, the general implied volatility index for SP500, VIX remains around the 30 level,. The 500 biggest US companies included in the SP500 are a proxy for the global wealth. When  the VIX index is high it signals dangers for the global wealth evolution. The contrary happens when VIX is below its long term average the 21 vol points level. Exogenous shocks such as COVID19 pandemic and now the geopolitical turmoil with Russia invading Ukraine, keeps the index at high levels forcing the investors to look for safety rather than investing on equity projects.

Putin’s aggression is certainly disruptive for the growth prospects. Spain is an important market and cross road for the global trade. We believe that the price pressure that the Spanish economy faces are below the potential production capacity of the economy. Inflation measures the strength of the change in those prices. The balance sign reflects imbalances of the demand and supply caused by misalignments of the producers response to the consumers demand. If there are bottlenecks on the supply side due to rising input costs relevant for producing the goods and services demanded production becomes costlier.  Consider for example the spikes of gas and oil prices and their supply chain effects.  While supply costs rise consumers on the demand side are also hit by those energy prices reducing their disposal income.

Under these circumstances, companies postpone investment projects, and therefore the internal demand that is measured as consumption plus investment will not be as high as its been recently. We have experienced strong demand in goods and services as the Spanish economy came from the COVID19 induced nadir of extremely low consumption back to the usual pre pandemic levels. Fiscal policy injected as a response large amounts of cash to support company cash flow while saving the loss of wages. This helicopter money had fueled the V-shape recovery but it has a maturity, meaning it will not last for much longer because  expanding the country's debt obligations becomes highly expensive.

The new labor pact between the business and the workers is very contained in rising wages too fast. The corresponding negotiations take into account future expectations on the evolution in the cost of living. Being moderate signals also moderate rise in the consumers wealth and therefore is insufficient for robust demand growth. Labor costs is by far the largest part of the total cost for producing goods and services.

All in all we don't expect demand to be very buoyant also considering that private debt carried from one year to another limits the consumers disposable income too. Therefore if internal demand is equal to consumption plus investments, high volatility will decrease demand and output will be further away from its potential. We don't expect prices to grow sustainability higher, but more likely we will experience occasional spikes that mean revert relatively quickly.