Irish households are facing the biggest drop in living standards since the 2008 financial crisis as earnings from work fail to keep pace with soaring inflation, the Economic and Social Research Institute (ESRI) has warned. The institute also forecasts a possible slowdown in house price growth on the back of rising interest rates.
In its latest Summer Economic Commentary, the ESRI said the Irish economy was continuing to perform strongly and would grow at a rate of 6.8 per cent in gross domestic product (GDP) terms this year and by 4.8 per cent in 2023 on the back of strong exports from the multinational sector.
However, it said the persistent increase in inflation and uncertainty due to the war in Ukraine would eat into the performance of the domestic economy.
With inflation expected to average over 7 per cent this year and earnings expected to grow by just 3.5 per cent, real incomes will contract by up to 4 per cent, the ESRI said, representing the biggest drop in living standards since the 2008-2009 period when the economy imploded in the face of a global credit crunch.
The expected increase in interest rates — the European Central Bank has signalled a sequence of rate hikes from next month — was also likely to dampen investment sentiment, consumer spending and growth in property prices, it said.
While the ESRI expects population growth and supply constraints to continue to support house prices in the near term, it judges that in the absence of these factors, a half point rise in interest rates would trigger a 2 per cent decline in values, with a greater impact if people believed further rate hikes were on the way.
So far consumer spending, the biggest component of domestic demand, has remained strong in the face of the current cost-of-living squeeze. However, as household bills rise and pandemic savings are run down, this could quickly change, the ESRI warned.
“Policymakers must be particularly attuned to the difficulties posed by high inflation rates; there is still some fiscal space to assist those most affected by higher costs of living, however this must be done in a targeted manner,” it said. The think tank said buoyant taxes and strong growth would deliver a budget surplus this year of approximately €1.6 billion, considerably more than previously envisaged, giving the Government some fiscal headroom for cost-of-living measures in the budget.
The ESRI also assessed the likelihood of a wage-price spiral developing in the Irish economy as a result of the current hike in living costs.
It forecast that while average annual wage growth of 3.5 per cent this year and 4.5 per cent in 2023 was strong in the context of the last 10 years, it was significantly lower than inflation. However, it noted that should unemployment fall below 4 per cent “this would be historically low in an Irish context and could result in a further escalation in wage rates”.
Despite rebounding strongly from the Covid-19 pandemic, the domestic economy faces significant downside risks, none bigger than Russia’s military invasion of Ukraine, which has triggered a humanitarian disaster and amplified a number of pre-existing macroeconomic risks.
“The acceleration in food and energy prices brought on by the ongoing war has further elevated inflationary pressures, with the impact on basic foodstuffs and energy for low-income households and poor countries being particularly acute,” it said.
At the same time, the UK government continues to add uncertainty to ongoing Brexit negotiations “through its unilateral legislative moves to alter the Northern Ireland Protocol”, the ESRI said, while noting the ongoing poor performance of the UK economy, as a major export destination for Ireland, posed a risk in itself.
Separate figures from the Central Statistics Office published on Wednesday showed the price of goods leaving factory gates — wholesale prices — rose at an annual rate of 7.3 per cent in May, reflecting the increase in input costs across the economy.