Salary hikes may trigger inflation ‘spiral’, Central Bank warns

The Central Bank has warned against salary increases across the economy to keep up with soaring consumer prices as a result of the Covid-19 pandemic and Ukraine war. It cautions that such a move may result in a longer period of "harmfully higher inflation".

Irish inflation, currently running at a four-decade high of 6.9 per cent, is expected to peak 8 per cent during the summer, said Mark Cassidy, the bank's director of economics, ahead of the publication of its latest quarterly economic bulletin on Wednesday.

The bank has raised its full-year inflation forecast to 6.5 per cent from the 4.5 per cent predicted in January before Russia invaded its western neighbour, a move that accelerated already-rising energy, food and other prices.

The pick-up in inflation has also prompted the bank to shave its growth forecast this year for the underlying Irish economy – measured as modified domestic economy – to 4.8 per cent from 7.1 per cent previously, as it tempers consumer spending, investment and exports.

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“It is critically important, and experience shows, that you do need to avoid this situation where wages and prices become automatically interlinked and you get this spiral where they’re chasing each other upwards,” Mr Cassidy said. “In that case, ultimately, the economic effects are negative for households and firms.”

Still, he said “some increase” in wages “is very welcome”.

Pay deal

The comments come as the Government heads into talks later this month on a possible new public sector pay deal. The public sector committee of the Irish Congress of Trade Unions (Ictu) has invoked a change-in-circumstances clause to a review of the current accord on the back of rising inflation. Ictu president Kevin Callinan said last week that the organisation's private sector arm has advised union officials to lodge pay claims of between 2.5 per cent and 5.5 per cent, with the higher figure in line with the official Irish inflation rate for February.

As things stand, the Central Bank sees the increase in remuneration of employees in the Republic growing from 2.3 per cent this year to 4.7 per cent in 2023 before topping 5 per cent the year after. However, real overall wages, when inflation is taken into account, are set to fall in 2022 for the first time since 2013.

The Central Bank used its latest quarterly bulletin to repeat a point made by its governor, Gabriel Makhlouf, to the Oireachtas joint finance committee last week – that policy measures to ease the impact of soaring inflation should be targeted and temporary, so that they do not contribute to the problem.

Lower incomes

Central Bank research has shown that households on lower incomes, older individuals and those living in rural areas are being disproportionately affected by the recent spike in inflation, because they tend to spend more on energy and food, where costs are rising most significantly.

The Government’s €855 million measures announced over the past two months to ease the impact of inflation on households and businesses has largely been broadbased, through energy credits and fuel excise cuts.

“With the public finances in a deficit position following Covid-19, this additional expenditure will be funded by borrowing,” the Central Bank report said. “If, for any reason, these measures became quasi-permanent, appropriate funding through current resources would have to be considered to avoid introducing a structural vulnerability in the public finances.”

The Central Bank said there was a “much higher level of uncertainty” surrounding the Irish fiscal outlook than normal, especially surrounding the final cost of pandemic support measures and effect of the Ukraine war.

“The latter includes both expenditure on providing humanitarian support for refugees and measures introduced to mitigate the impact of high energy prices,” it said.

Minister for Public Expenditure Michael McGrath has estimated the cost of welcoming 100,000 refugees to Ireland will be between €1.4 billion and €1.7 billion this year, funded from the Government's pandemic contingency fund. The cost for next year could be as high as €2.8 billion.