Energy prices and inflation expected to fall next year, says Department of Finance

Energy prices are expected to fall next year, though the price level is expected to remain high, while a significant easing in inflation is also anticipated, the Department of Finance has said.

Brendan O’Connor, the department’s principal officer and head of macroeconomic analysis, told a meeting of the Oireachtas Budget Oversight Committee on the cost of living that the war in Ukraine has created a “large supply-side shock that has shaken the global economy”.

“Looking ahead, higher energy and commodity prices are expected to continue to feed into higher inflation over the coming months,” he said.

“Inflation is expected to remain elevated in the near term, peaking in the second quarter and averaging 6.25 per cent for the year as a whole.

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“Pass-through price effects are also expected in other sectors such as food, via higher fuel and fertiliser costs, and consumer goods and services, due to higher energy inputs, with core inflation of just under 4 per cent projected for this year.”

However, he added that a “significant easing” is anticipated in inflation next year, with the headline rate projected to average 3 per cent for 2023 as a whole. “Indeed energy prices are expected to fall next year, though the price level is expected to remain high,” he continued.

“Higher energy and commodity prices will erode real incomes of households while also denting the margins of firms.

“This, alongside heightened uncertainty will dampen consumer spending and private sector investment in the near term. In this manner, higher inflation will act as a headwind on output growth this year.

“As a result, we have revised down our forecast for modified domestic demand growth this year by 2.25 percentage points, with growth of around 4.25 per cent now projected for this year.”

Uncertainty

Mr O’Connor cautioned that the projections were produced against a backdrop of “exceptional uncertainty”, and that, as such, risks to the forecast “are considerable and firmly tilted to the downside”.

He also outlined a scenario in which wholesale oil and gas prices return to their early-March levels and remain elevated relative to baseline throughout this year and next.

In this scenario, inflation would be 2 percentage points higher this year at 8.25 per cent, peaking at 9.25 per cent in the third quarter, and 1.25 percentage points higher next year at 4.25 per cent.

“The energy price shock would not only affect inflation, but would also have broader macroeconomic implications,” he said. “Output in the domestic economy would be around 2 per cent lower over the medium term while the projected surplus for next year would be wiped out.”