Spain

In Spain, the reopening of the economy post Covid-19 boosted growth in 2021 (+5.1%). However, inflationary pressures, supply-chain disruptions and the Russia-Ukraine conflict have worsened the outlook in the short term. Swings in consumer spending played an important role in growth in the first half of the year, with a decline in Q1 and a strong rebound in Q2, and investments have kept up a good momentum. As a whole, the economy slowed in Q1 by 0.2% and grew by +1.3% in Q2, the latter well above market expectations (+0.4%). While we expect less support from household consumption in the coming quarters due to high inflation, growth is likely to remain robust in Q3, supported by EU-funded investments, the steady recovery in tourism during the summer and the strong labor market. That said, consumer and business confidence, as well as PMI data, suggest that growth momentum might be fading. We expect growth to remain robust in 2022 (+4.3%), but to contract in 2023 (-0.3%) due to heightened uncertainty, high inflation denting consumer spending, falling external demand and deteriorating financial conditions, which will constrain business investments. In this sense, we expect to Spain's economy to return to its pre-pandemic size only in 2024.

The current objective is to address the issue of high energy prices, amounting to EUR15bn in direct aid, tax cuts and fuel-price reduction; EUR10bn in loans to companies, gas cap prices for power production and, more recently, reducing the VAT from 21% to 5% for domestic natural gas. Despite the help from the fiscal measures, inflation is extremely high and ran above 10% between June-August 2022, with a slight deceleration observed in September. Although food and energy are the main drivers of inflation, core inflation is escalating, too, meaning that price pressures have been disseminated. Given our outlook for food and energy prices, we expect inflation will remain elevated in Spain until the end of 2023 (+5.7% for the average of the year).

Wage growth remains moderate, increasing by 2.5% on average in H1 2022, and the share of wage agreements with indexation clauses remains moderate, though this is rising. For the year, we expect wage growth to increase by 2.8% on average, i.e. significantly below inflation, which will result in a loss of purchasing power. Unemployment remains high but has declined more than expected and the labor reform approved in February 2022 might limit the widespread use of short-term labor contracts. After reaching 15.5% in 2020, Spain's unemployment rate fell to 14.8% in 2021. We forecast it to decline to 14.1% in 2022, the lowest level since 2008.

In the 2021 budget, the government allocated EUR27bn (2.3% of GDP) of the EUR69.5bn in grants it requested from the Next Generation EU (NGEU) facilities over 2021-2026, mostly from the Resilience and Recovery Facility (RRF) with EUR59.2bn and REACT-EU with EUR12.4bn. The funds are mostly destined to finance green and digital projects as well as job creation. The 2023 budget is expansionary despite targeted tax increases e.g. banks and wealth and thanks to more projected NGEU spending, which has underperformed so far.

Spain is ranked 31 out of 190 economies in the World Bank's Ease of Doing Business rankings, ahead of other major European economies such as France (33), Italy (58) and Portugal (39). Despite reforms since the 2008‑09 crisis, structural weaknesses persist, particularly an over-reliance on tourism and labor market inefficiencies.

Spain faces higher risks to employment, given the predominance of SMEs, which are more vulnerable to liquidity shocks, and the high share of temporary contracts. Spain relies on EU demand and supply more than other country and energy prices have escalated faster than in Eurozone overall, which worsens the balance of risks. As a result, sectors such as transport, the electro-intensive industry and construction might be significantly affected.

Despite pressure from the energy crisis, the Spanish government's ability to provide more fiscal support is limited due to persistent primary deficits. Recently the left-wing central government announced a temporary wealth tax in 2023 to help finance the extra fiscal costs. Note that with municipal and regional elections next May, the risk of fiscal slippage could rise.