ESRI sanguine on pound factor as economy may grow by 7%

The Economic and Social Research Institute has played down concerns about the affect which the falling value of the pound against sterling will have on inflation next year. In its Quarterly Economic Commentary issued yesterday, the ESRI has forecast that the rate of inflation will rise to around 2.5 per cent next year, well below the 4.4 per cent increase forecast earlier this week by Davy Stockbrokers and in line with the latest forecast from the European Commission.

In an upbeat assessment, the ESRI has forecast that the Irish economy will rapidly expand again this year, growing by 7 per cent. This compares with the ESRI's 5.5 per cent forecast for GNP growth in its April commentary.

Although this is slightly below official annual estimates of an average of 7.5 per cent for the past three years, the continuing good growth should support the creation of over 50,000 new jobs in the economy in 1997. This is marginally higher than the average achieved in the previous three years, when the number of new jobs created annually in the economy was around 46,000.

In 1997, the ESRI has forecast some acceleration in prices in the second half of this year, which should push the average inflation rate up to 1.75 per cent. The authorities' success in maintaining the pound as one of the most stable currencies in Europe over the past 12 months should preclude a more rapid rise in prices this year, according to the ESRI.

The ESRI believes that 1998 will see a reversal in the recent performance of sterling and the deutschmark and this will help to dilute further inflationary pressures, although the average rate will tick up to about 2.5 per cent.

A substantial depreciation of sterling, which it states is already overdue, is "very probable" in the second half of 1997 or more probably in 1998, while an appreciation of the deustchmark against non-ERM currencies is also likely next year after the uncertainties surrounding the single European currency project lessen.

The rise in inflation will not, however, hamper Ireland's entry to the single European currency. The figure on which membership is expected to be based will most likely be 1997, which even at 1.75 per cent will still be acceptable.

ESRI economist, Dr Terry Baker, said yesterday that the substantial difference between his forecast and that produced by Davy stockbrokers, was probably due to varying methods of calculation.

Earlier this week Davy economists, Mr Jim O'Leary and Mr Michael Crowley, forecast that the 16 per cent fall in the value of pound against sterling over the past 12 months would trigger a sharp rise in inflation to an average of 4.4 per cent. Davy's expect inflation to peak at 5 per cent in mid-1998 but to fall to 4 per cent by the end of next year.

The ESRI accepts, however, that while there have been no significant surge in inflation to date, there is some concern that it will re-emerge. "The decline in continental European exchange rates may mean an increase in inflation as higher import prices feed through," it states. Based on this scenario, it predicts some fall in European interest rates towards the end of this year or in early-1998.

Between now and the end of 1999, the ESRI said, much of the international macro-economic focus will be on the progress towards EMU which will create some tensions. "The EMU project has suffered from increased uncertainty in recent months which has also contributed to exchange rate fluctuations. While it seems certain that strong political motivation will ensure that EMU starts on time, it seems likely that the period to its commencement will be marked by strong exchange rate reaction to progress reports," according to the ESRI.

Dr Baker insists, however, that there are no sharp shocks in terms of short-term interest rate hikes likely, predicting very little movement in Irish rates for the rest of this year. Assuming that EMU goes ahead on time, he said Irish and German interest rates would become almost identical from the beginning of 1999, holding out the prospects of lower interest rates. Irish rates are likely to fall in late 1998 but will only be marginally lower than current levels.