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Is Spain's recovery at risk from deflation?

After battling a financial crisis, burst property bubble and recession, Spain now appears to be on the road to recovery but some analysts have warned it could be a bumpy ride, with the dangers posed by deflation looming large.

Despite a high-profile banking crisis and property meltdown just three years ago, the Bank of Spain now expects the Spanish economy to have grown by 1.4 percent in 2014, and to expand by 2 percent in 2015, led by domestic demand.

Madrid skyline at sunset
Victor Pelaez | iStock | Getty Images
Madrid skyline at sunset

In the third quarter of 2014, Spanish gross domestic product (GDP) grew 0.5 percent quarter-on-quarter, compared to a euro-zone-wide figure of 0.2 percent.

But despite firm growth figures, the country's inflation data makes for somber reading. In December, the consumer price index (CPI), which tracks the prices of an everyday basket of goods, fell to -1 percent from a year earlier.

It comes after figures last week revealed that the euro zone slipped into deflation in December, boosting expectations that the European Central Bank (ECB) will initiate a full-scale government bond-buying program in the near future.

While falling prices could be good news for consumers to some extent, deflation can be a double-edged sword for national economies.

There are fears of a deflationary spiral setting in – where consumers delay spending in the expectation that prices will fall further, as happened in Japan – and the real value of both money and debt rises, putting pressure on the economy.

Jonathan Loynes, chief European economist at Capital Economics, said that Spain was particularly vulnerable to deflation, and argued that the latest figures could not be blamed solely on the falling price of oil.

"While Spain's economic recovery remains solid, its high unemployment and large degree of spare capacity make it vulnerable to a prolonged bout of deflation," he wrote in the consultancy's forthcoming quarterly report, yet to be published.

"Spain has been one of the euro-zone's stronger performers over recent quarters. And timely survey evidence such as the composite PMI (Purchasing Managers' Index) show few signs of any significant loss of momentum. But this may not be sustainable."

In the report, Loynes, along with Roger Bootle and Martin Essex at Capital Economics, said that a prolonged period of deflation could hit the country's debt consolidation and "could necessitate further austerity measures" -- something that Prime Minister Mariano Rajoy, who trails the populist, anti-austerity Podemos ("We Can") party in the polls, might well be reluctant to do in 2015, an election year.

Four factors to watch

But not everyone is so concerned about Spain in the near future, with the country's trade secretary saying that its growth figures could be conservative.

Inigo Fernandez de Mesa argued that there are four factors that could "impact positively on the Spanish economy this year."

"The sharp reduction in oil cost reduces the cost of production and possibly increases the income of families and it also improves the external account of Spanish economy," he told CNBC on Thursday. "The second positive factor is the exchange rate depreciation. This could be a very important factor to improve the performance of Spanish exports further."

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Speaking to CNBC in Madrid, Fernandez de Mesa said that Spain's economy could also get a boost from a a "rapid reduction" in funding costs and wage moderation (stopping wages from growing too quickly).

"All these factors impacting simultaneously could make our forecasts for this year conservative," he added.

Oil prices have declined around 60 percent since June 2014 and the euro has weakened almost 7 percent against the dollar over the last three months.

- By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt. Follow us on Twitter: @CNBCWorld