Danny McCoy: Inflationary pressures but bedrock of economy strong

Over the past 10 years, we have faced, and largely weathered, as a country three “once in a lifetime events”: one of the largest financial and fiscal crisis in history of the developed world, the exit of our nearest neighbour and traditionally most significant economic partner in the EU and, most recently, the worst global pandemic in a century.

In the eyes of many commentators, the economy now faces into yet another defining challenge as the country tackles levels of inflationary pressures not witnessed in decades.

While the country has experienced worrying inflation rates in the past, the Ireland of today is a very different economic beast from that of the 1970s and 1980s.

Unlike previous generations, the underlying business model of today remains strong and can deliver growth despite emerging challenges. Indeed, there are even substantial opportunities for the economy to seize, such as improved energy policy in the long term given the emerging technologies.

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For the economy more broadly, a delicate balancing act from policymakers is required for this year and next, to ensure a sustainable path to recovery.

The ongoing and devastating Russian invasion of Ukraine has left the global economy in a state of flux and has been identified as the catalysing force behind many of the drivers of inflation in sectors such as energy, food and other commodities seeing a sharp rise across global markets.

The knock-on impact of rising costs on business investment will be significant and operate through three main channels.

First, rising construction costs will make new investments and housing completions relatively more expensive.

While last week’s announcement from the Government that it would pay up to 70 per cent of builders’ inflation-related construction costs will mitigate some of the impacts, we can still expect a slowdown in new investments and some investments may be unviable in the short run.

Energy prices

Second, concerns about rising energy and commodity costs may take precedence over new investments when it comes to management of company resources in the short run.

Third, uncertainty about the future path of both energy prices and demand in the economy will slow decision-making on new investments. Together these impacts will weigh on new investment in 2022 and into 2023 but may create new opportunities in the longer run. In particular, a higher price level for fossil fuels will create a lower relative cost of renewable investments.

Despite these challenges, the underlying business model of today remains strong and can deliver growth. Indeed, the Irish economy had been recovering rapidly from Covid before the Russian-Ukrainian war crisis hit.

This momentum provides some buffer to the impact of the war in 2022 but the outlook for 2023 is more muted.

Our central expectation is that the economic impact from the Russian invasion of Ukraine will knock somewhere between 1-2 percentage points off the rate of growth relative to the 6.1 per cent we expected for 2022 in Q4 2021. Economic growth will still be positive at about 4.3 per cent in the year ahead.

Furthermore, Irish households come into this period with record savings. At its peak during the first half of 2021, Irish household savings were rising by over 17 per cent annually.

While the reopening of the economy in the early part of 2022 resulted in some slowdown in the rate of deposit growth to 9 per cent annually, we have yet to see significant drawdown on existing savings.

At the end of February 2022, Irish household deposits had risen by €30 billion on the same month in 2020, to over €142 billion. This is €22 billion ahead of their trend growth rate from the 2017 to February 2020 period.

Standard of living

Given their concentrated nature in the top-half of the income distribution, however, they do suggest greater effort should be made to target any fiscal supports against inflation at lower-income households where “excess” savings are likely to be lower. It is vital these households and businesses should be supported appropriately.

However, the impact on standard of living and competitiveness must be viewed from a perspective of how it has developed over the past five to 10 years of strong economic growth.

What must also be factored in is that the country is facing a tight labour market across most sectors.

Surveys we conducted just before Christmas last year showed that most Ibec members were undertaking pay increases in 2022 – with a median increase of just under 3 per cent expected.

Although increased pressure due to higher inflation has not been seen in pay agreements at a local level thus far, a longer period of sustained inflation may well introduce further upward pressure on wages in the economy.

On the other hand, many of our members have reported that general economic uncertainty, rising costs and the challenge of price recovery may have altered demand for labour and expectations in the interim.

What is for certain is that companies are likely to see rising costs of employment in the coming years.

Ibec research indicates that the rollout of auto-enrolment, the living wage, statutory sick pay and other leave proposals already announced will add about 2.8 per cent to the total wage bill in the economy in the coming years.

In the longer term, the addition of higher PRSI for employers and employees in line with the Commission on Pensions recommendations and rising auto-enrolment rates will increase this to 9 per cent.

This is before any new proposals emerging from the Commission on Taxation and Social Welfare.

While many of these additions to the so-called social wage have merit on their own terms, it is crucial that the Government intensifies work through the Labour Employer Economic Forum to ensure better co-ordination of tax, social welfare and other social wage policies that can address these inflationary pressures.