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Covid hit some incomes, this crisis will hit everyone’s

The inflation rate could approach 9 per cent, with a big shock to the cost of living

Much higher inflation, lower growth but – probably – no recession. That is the initial conclusion of most economists as they try to make sense of the likely impact of the war in Ukraine. But these predictions must only be tentative. The path and duration of the conflict will be the key determinant, influencing energy and food costs directly and with a big impact on Ireland’s export markets and economic confidence. The risks of further damage to the economic outlook are substantial, particularly if the conflict drags on or deepens, or if Russian gas supplies to Europe are stopped.

The economic impact on households is like a big increase in income tax rates or a cut in welfare payments. It is money directly out of people’s pockets. Covid-19 hit the incomes of just some of the population – those working in the exposed sectors. The latest crisis will hit everyone.

Businesses, meanwhile, are facing huge cost increases, with gas, diesel and ESB bills shooting higher. The debate in the Dáil about firms "profiteering" is a sideshow. Ireland is an energy importer and just about every business is facing a big increase in costs. And so there is a threat here to jobs, as well as the immediate hit to household spending power.

Economic growth forecasts for this year are being revised down, according to Kieran McQuinn, research professor at the ESRI, who is part of a team currently working on updated predictions for 2022. All the main engines of the economy will be affected, he said, with growth in consumer spending and investment significantly lower and a serious impact on the global markets Ireland sells in to, particularly in Europe.

“We still think the economy will grow but the downside risks are substantial,” he said. And the rate of inflation, previously estimated by the ESRI [Economic and Social Research Institute] at 4 per cent, is likely to average 6 per cent to 7 per cent this year, with the rate peaking at 8.5 per cent in the months ahead. Here is one of the big uncertainties – after a week when gas prices doubled in a couple of days and have now returned to roughly where they were on Monday, nobody really has a clue where they will go next.

McQuinn warns that with food prices also rising – as wheat and fertilizer prices surge – and signs of general price and wage pressures there is a “growing underbelly of domestic inflation” to add to the external price threats. Siptu is this weekend seeking a review of the public sector pay agreement to account for the surge in prices. Inflation, in some form, may be here to stay. The ESRI’s UK counterpart, the NIESR, has made an initial stab at forecasts, predicting that the war could cut global GDP by 1 per cent by 2023 and lead to inflation being three percentage points higher. If anything, the likely cut in initial economic growth forecasts for Ireland may be a bit higher, though still leaving growth in positive territory.

There are nerves in Government too, where the cut in excise duties until the end of August has a significant cost of €320 million, but offers a limited benefit to motorists in prices continue to surge higher. Ministers have underlined repeatedly that the Government cannot insulate consumers and businesses from what is happening, but that will not insulate them from the political flak. And nobody knows how long the energy spike will last or how bad it will become. Minister for Finance Paschal Donohoe is likely to resist immediate calls to do more. But the crisis may well push the Government to take wider action, for example to protect less well-off households.

A lot will depend on what happens at EU level, with discussions underway on more flexibility on VAT and excise duties and even proposals to look at capping electricity prices. The Government must also pencil in significant costs from dealing with a big inflow of refugees. Here again there is huge uncertainty. Minister for Public Expenditure Michael McGrath says he believes there is enough money in the budget for 2022 to deal with this. But will these people, uprooted so suddenly from their homes, be able to return home in a few months, or are they here for a prolonged period?

Businesses are also looking for help – urgently. Sources say that big companies renewing annual supply contracts are in some cases facing quotes three or four times higher than their existing plans. For SMEs the pain has been faced by more regular rises and is continuing. Meanwhile, huge tensions have emerged in parts of the food sector, with rocketing feed costs putting pressure on pork and poultry firms who are now at war with retailers over prices.

In a letter to Government ministers on Friday Ibec – the business lobby group – says the Government urgently needed to channel cash to companies, many of which will otherwise go out of business, within the context of an emergency EU framework being developed. “Firms and jobs will be lost if Government does not do more to address this energy crisis,” according to Ibec CEO Danny McCoy.

Ibec is also calling for plans for rapid moves on energy storage facilities to give the State some flexibility moving into next winter – and for a much more rapid roll-out of renewable energy projects.

Energy supply – as well as energy prices – are now vital issues for businesses and Ibec’s call for early publication of a promised review of energy security and of strategies for the use of hydrogen is significant.

Everything now depends on the course and duration of the conflict. An early – and stable – negotiated settlement would lift a lot of the economic threat. But in Government buildings this is not expected, as of now anyway. And while there is enough leeway in the budget for this year to take on a significant additional cost in dealing with this – and probably stay within budget forecasts for this year – there are now risks.

Ireland emerged from Covid-19 in remarkable good economic shape, bar a hit to a few key sectors. The Government strategy this time is likely to be similar – to try to roll out economic supports in stages, as needed and depending on how events pan out. But the national debt shot upwards during Covid-19 and with the ECB signalling this week that interest rates could be on the rise later this year, the State may soon be paying more for its borrowings.

The cost of debt may remain low by historical standards, but as ECB support is withdrawn it will rise and the markets will start to focus again on how each country is making its exchequer risks. It all adds up to less room for manoeuvre and a rising exposure if, for example, economic growth takes a heavier hit, or corporate tax revenues, which have helped pay a lot of the bills in recent years, fall away.

So the economic risks are on the rise again. We can hope that the economy, which was resilient through Covid-19, will again cope. But we are at the mercy of events beyond our control.