Spain: Inflation and Labor Unrest May Spoil Recovery

Spain's economy is showing its poorest performance in five years. While the worst is believed to be over, uncertainty over inflation and labor unrest could jeopardize the recovery.

First-quarter real gross domestic product grew 0.5% from the fourth quarter. Compared with a year ago, real GDP is up 2%, the smallest rise since 1998. For all of 2002, the government expects real GDP to grow by just 2.4%, down from 2.8% in 2001.

Forecasters expect Spain's economy to improve through the course of 2002, but the second quarter is showing scant signs of better health. April industrial production rose by 1% from a downwardly revised March. But growth was concentrated in construction-related areas dominated by government pump-priming. Prime Minister José María Aznar hiked public-works outlays by 10.4%, to $8.2 billion for 2002. Capital-goods production fell 8.1%, a sign that business confidence is still weak.

Although the Labor Ministry said that May jobless claims fell more than expected, job growth was limited to seasonal industries such as tourism. Meanwhile, the number of job seekers increased. If employment can't be created fast enough, consumer spending, which until now has been resilient, could falter.

The government's attempt to get more people back to work may weaken the labor markets further. Madrid enacted a new measure to cut unemployment benefits to job hunters who refuse positions that pay less than they want. Unions are protesting loudly. If repeated strikes result, the disruption to business activity could deal a serious blow to business confidence and hiring.

Inflation could also slow the recovery. Spanish consumer prices in May rose 3.6% from a year ago, up from 2.7% in December. And euro zone inflation in 2002 is expected to run above the 2% target set by the European Central Bank. Rising inflation could force the ECB to raise rates by September, creating more headwind for Spain's shaky recovery.

By James Mehring in New York

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