Inflation rises sharply to hit a three-year high at 2.5%

The expected pick-up in Irish inflation has arrived in the shape of a 2.5 per cent increase in the year to April.

That figure is the highest annual rate since May 1995 and leaves the State with one of the top rates of inflation in the EU up from one of the lowest just months ago.

The figures coincided with a renewed call for pay restraint by the Minister for Finance who told an Irish Business and Employers Confederation dinner last night that large increases in public expenditure ran the risk of adding to inflationary pressures.

In a strongly-worded speech, he warned that he was determined to limit spending and pointed out that this was now required by Brussels.

He said this had "particular implications" for the public sector pay bill and that past increases where the bill doubled over 10 years could no longer be afforded. "We simply will not be able to afford the level of increases we have seen in recent years, no matter what the reasons for the increases might be."

He also warned that excessive pay demands would undermine the competitiveness of the entire economy, restrict the scope for further tax reform and ultimately lead to reduced employment.

According to Mr Jim O'Leary, chief economist at Davy Stockbrokers, the inflation rise is due to the fall in the value of the pound last year although the resultant pressure took longer to filter through than had been expected.

Correspondingly, the recent strengthening of the pound against sterling is unlikely to have a positive impact on inflation until the turn of the year, he added.

He is expecting a further acceleration with inflation peaking at around 3.5 per cent although he concedes that that forecast may even be a little "conservative".

The inflation increase will be deeply embarrassing to the Central Bank, according to Mr O'Leary. There is little it can now do to influence inflation and impending monetary union will force it to cut interest rates as inflation picks up. Normally, the bank would be raising rates under these circumstances but the requirement to bring them into line with those in Germany means that that option is no longer open to it.

However, whether the Bank decides to wait for a German rise before cutting rates here or opts to go for a reduction on its own is impossible to predict, Mr O'Leary says.

"The problem with trying to double guess is that the policy does not conform with any logic with which I am acquainted, and as such requires a framework which I do not have."

The figures released for April yesterday also showed a monthly rise of 0.5 per cent the third in a row of that magnitude.

The biggest contributor was food which increased by 1.3 per cent in price in April and made up almost two-thirds of the rise in the index. Some of this was due to bad weather and potato blight, but rises in cereals, biscuits and margarine were attributable to British imports. Food has now risen by 4.2 per cent over the past year.

Tobacco prices are also up, but this is more the result of an industry-wide price rise. And according to Dr Dan McLaughlin, chief economist at ABN Amro, package holidays and possibly some upward pressure on wages contributed to a 3.6 per cent rise in the so-called "services" category. This increase is also likely to be exchange-rate related.

The price war in the clothing and footwear sector, which kept inflation low last year, also appears to be well and truly over.

Mr Colin Hunt, senior economist at Bank of Ireland, said there was a danger inflation would be running at comfortably above 3 per cent at the end of the year, he said. "That is too high for an export reliant economy about to participate in a fixed-exchange-rate regime."