Economists hope for sterling fall to curb inflation

Economists are pinning their hopes on a fall in the value of sterling which is now required if the inflation rate here is to fall back as we move into monetary union. Forecasters believe the inflation rate could rise to well over 3.5 per cent, but expect it will ease moving into next year as sterling falls back and takes the pressure off import prices.

Most business and employers' organisations took a cautious approach to yesterday's figures, which showed an annual rate in June of 2.9 per cent. But several have warned that there could be a problem with Partnership 2000 by the end of the year, if price increases do not slow down.

The inflation rate is the highest among the 11 countries who will be founder members of EMU and is set to move even further away from the EU average. Inflation has been rising steadily for four months. Prices have risen by 0.5 per cent in four of the last five months, and by 0.4 per cent in May; the annual rate has now risen from 1.8 per cent in January. Irish inflation is now running well ahead of the other euro-zone countries. For comparative purposes across the union, a slightly different method of calculating prices than the normal consumer price index is used. On this EU-harmonised basis, Irish prices rose by 2.6 per cent in the 12 months since June 1997. The latest figures for all of the EU relate to May, when the Irish "harmonised" rate was 2.4 per cent, compared with an average of 1.4 per cent among the euro-zone countries.

Economists warn that prices are set to accelerate even further over the summer. According to Mr Jim O`Leary, chief economist at Davy Stockbrokers, the inflation rate is likely to reach 3.4 per cent or 3.5 per cent in August and could even be higher.

One of the major problems with rising prices is that they are eroding the value of savings, on which many pensioners and others rely. If the annual inflation rate does approach 3.5 to 4 per cent, it will be running at above the rate which many savers will be able to find on the market.

There may also be pressures on Partnership 2000, if the inflation rate continues to rise. The agreement was negotiated on the basis of average inflation below 3 per cent. While there is no immediate risk of an uncoupling of the agreement, most of the social partners are pinning their hopes on inflation falling back towards the end of the year.

But this is based on the assumption that sterling will fall back. The rise in sterling has been a major factor putting pressure on prices here, as it has increased import costs from Britain. But while most forecasters now expect the British currency to weaken, it cannot be guaranteed. Mr O'Leary also warns that wage inflation has already taken hold. The main issue, he added, is what is allowed to happen in the public sector.

"In the end it will all come down to political resolve and how seriously the Government intends to impose the spending cap. There is no point keeping to spending caps in the aggregate and having a soft line on pay. You could end up with highly paid teachers without chalk."