Exchange rate trend raises pressure at national pay talks

ANALYSIS: The euro's advance is the dominant force in the erosion of Ireland's competitiveness.

IRELAND'S REAL competitiveness on international markets deteriorated by 12.5 per cent during the 27-month span of the last pay deal, according to data compiled by the Central Bank.

However, this substantial erosion in real competitiveness was almost wholly attributable to the strengthening of the euro against sterling and the US dollar. Ireland's inflation rate relative to trade rivals played a relatively minor role in undermining competitiveness over the period.

Real competitiveness declined by 7.3 per cent in the year to March 2008, with virtually all of the competitive losses triggered by exchange rate changes.

These results are derived from the Harmonised Competitiveness Indicators (HCIs) for Ireland, published monthly by the Central Bank.

Taking a longer perspective, Ireland's real competitiveness on global markets has fallen by 30.6 per cent in the six years to March 2008.

Again, the principal culprit was the continuous advance of the euro against the currencies of Ireland's two principal trading partners, Britain and the US.

These trends pose a major problem for Government and for the negotiators at the national pay talks that started last Thursday. There is no set of domestic policies that can counteract the effect on Irish competitiveness of exchange rate gyrations of the magnitude seen over the past two years. However, poorly-framed or executed domestic policies can make a bad competitive situation worse.

Ireland trades extensively with both Britain and the US. In 2007, these two countries purchased 36 per cent of Irish merchandise exports, while 44 per cent of Irish goods imported originated in Britain and the US.

As a result, both sterling and the US dollar have been assigned heavy weights in the composition of the nominal trade-weighted Irish exchange rate.

Table 1 shows the evolution of Ireland's nominal trade-weighted exchange rate and the real exchange rate since the euro was launched in 1999. As can be seen, in the first three years of euro membership, the nominal trade-weighted exchange rate depreciated due to the strength of the US dollar and sterling during this period.

Ireland's inflation rate accelerated sharply in the early years of the new decade. However, insulated by the depreciation of nominal exchange rate, the real exchange rate still declined. As a result, during the first three years of the euro's life, Ireland's real competitiveness improved on international markets.

However, as first the dollar and then sterling began to slide on foreign exchanges in recent years, Ireland's real exchange rate began to appreciate rapidly, causing sustained competitive losses in the process.