The cost of living dropped slightly everywhere in Spain, except the Balearics, last month. The rate of inflation for July in the Balearics matched June while Spain experienced an average drop of 0.7 per cent. This year the cost of living in the Balearics has risen by three per cent and the inflation rate for the past 12 months is running at 3.7, the highest in Spain, above the national average of 3.4. Economists said yesterday that the summer sales have led to the 0.7 percent drop in Spain's consumer price index in July, but the yearonyear rise remained unchanged at 3.4 percent. Economists had been expecting the index to remain unchanged compared with June and the annual rate to stay at 3.4 percent, according to an average of 12 forecasts. Core inflation, which strips out volatile fresh food and energy components, fell 1.0 percent in the month but was up 3.8 percent in the year, an improvement from the 4.1 percent it reached in June. On a harmonised basis, comparable with other European Union data, Spanish consumer prices dropped 0.7 percent in the month but rose by 3.5 percent compared with the previous year. The main factor in Spain's surprisingly large July monthly drop in inflation was discounting in summer retail store sales, INE said. Clothing and footwear prices dropped 8.8 percent compared with a month earlier. Household goods prices also dropped 0.7 percent in the month, but prices in both the leisure and cultural activities and hotels, cafes and restaurants categories rose by 0.7 percent. Inflation has remained obstinately high in Spain and is one of the main economic problems facing the country together with high unemployment. The Spanish government earlier this month cut its 2002 gross domestic product (GDP) forecast, and said for the first time inflation would be way above target. Inflation will exceed earlier expectations in both years and the government had raised its GDP deflator forecasts for this year to 3.5 percent from the original 2.9 percent and for next year to 2.8 percent from 2.4, the government said. Economy Minister Rodrigo Rato said that by the end of 2003, inflation should have come down to around two percent. Spanish GDP growth, which is usually higher than the euro zone average and is seen as the upside of higherthanaverage inflation, is now forecast to slow to 2.2 percent this year from 2.8 percent in 2001 and four percent in the four previous years.