McCreevy faces testing time in framing budgetary arithmetic

The news on inflation and oil prices could hardly be worse. Inflation is running at 6.2 per cent for the second month in a row and, according to most commentators, is expected to rise further. This is not just the product of a very strong economy but is also the result of extremely high international oil prices and a very weak currency.

Oil prices on the international markets rose to near a 10-year high as traders said OPEC's agreement at the weekend to boost output by 800,000 barrels a day was insufficient to bring down prices or ease concern over low inventories of heating oil. Irish suppliers will raise prices over the next few days, raising the prospect of protest action here similar to in other European states.

The euro also remains weak although it did pick up very slightly yesterday following testimony to the European Parliament by the European Central Bank's president, Mr Wim Duisenberg. Nevertheless, there are few brave enough to predict when it will head back towards parity with the dollar. The one element of good news was that unemployment has fallen to 4.3 per cent, according to the Quarterly National Household Survey.

Compounding the problems facing the authorities is the pressure being applied by the unions for additional wage increases. The Partnership for Prosperity and Fairness was negotiated on the assumption of an average inflation rate of 2.5 per cent. The Minister for Finance Mr McCreevy has already raised his inflation forecast to 5.25 per cent for this year but many believe it will have to be increased further.

The resolve of the general secretary of IMPACT, a notable supporter of partnership, appears to be weakening. The general secretary of ICTU is being forced on to the backfoot and admitted that the deal is under pressure. SIPTU is also now warning that without a further deal on pay and tax it would be forced to start negotiating with individual employers outside the parameters of partnership.

The Government's strategy is undoubtedly to hold out until the Budget, take a view of the situation and then consider its response. That was an easier formula when it still hoped that inflation would be falling towards the end of the year and would be far lower next year. But now it seems likely that inflation will still be more than 6 per cent when Mr McCreevy stands up in December to make his Budget speech and it may not fall back significantly next year.

There is virtual unanimity that inflation will accelerate over the coming months - higher petrol and mortgage costs should see to that. But according to economists, the real concern is that inflation - buoyed by domestic demand rather than external factors - could become so ingrained that it threatens the medium term outlook for the economy.

The danger is that the pure strength of demand here will make it easier for business and producers to increase prices and even use currency and oil price movements as an excuse for more generalised price increases. . This would lead to a more stubborn inflation problem in 2001 with severe implications for the PPF and wage growth in general.

Large increases in wages may be affordable for exporting companies who are benefiting significantly from the weak euro. But any substantial turnaround in the currency could see that reversed.

So, all-in-all, in framing his budgetary arithmetic, Mr McCreevy is in a very difficult position for a minister who has more money in the coffers than any of his predecessors. He can afford tax cuts but should he give them? The same is broadly true of some wage rises. Another option is cuts in excise duty which could do the job in terms of reducing inflation but also have some negative impact.

In Dublin last week the ECB's Mr Duisenberg warned that large scale tax cuts could make the inflationary position worse. That is unlikely to stop the Minister delivering at least some - as evidenced by Mr McCreevy's article on page 16 of today's editions.

The Minister argued that he will keep to his ambition that 80 per cent of taxpayers should pay tax at the standard rate only and that commitments to lighten the burden of taxation for the lower paid will be honoured.

Whatever course he chooses, Mr McCreevy will need to have inflation at the forefront of his mind when framing the Budget. Both his own Department and the Central Bank - and nearly all other commentators - had assumed that oil prices would be weaker and the euro stronger next year, cutting inflation significantly. They reasoned that all the Minister would have to do would be to avoid another mistake like last year's excise duty increase on cigarettes which contributed to rising inflation. Now international markets as well as domestic circumstances have made his task more difficult.