Rise pushes State to top of EU table

Last July, the Republic's headline rate of inflation was running at just 1.2 per cent. Six months on and the position has deteriorated markedly, leaving the State at the top of the EU league table with an annual inflation rate of 4 per cent.

The larger-than-expected jump in January inflation to its highest level in 10 years is bound to fuel the debate on whether the economy can maintain the breakneck pace of growth of recent years.

The optimists believe the latest set of inflation figures should not give rise to undue concern about the economy because they are influenced by several significant distorting factors.

Chief among these is the big increase in the cost of tobacco following the Minister for Finance's decision to add 50p to the cost of a packet of 20 cigarettes in his December Budget. As a result, the price of tobacco was some 17 per cent ahead of the January 1999 levels last month, accounting for a large chunk of the overall rise in annual inflation.

In addition, the strong rise in international oil prices in recent months has taken its toll on inflation by increasing both fuel and light costs, which were more than 8 per cent higher in January than a year earlier, and transport costs, which were up 7.8 per cent.

Increases in the cost of tobacco and transport alone accounted for nearly half of the total 4 per cent rise in the index last month.

Also adding to the consumer price index was the increase in mortgage repayments following the half a percentage point rise in euro interest rates last November.

"The increase in prices is not systemic in that you see it everywhere. It's in specific areas like mortgages, petrol and tobacco," said Mr Dermot O'Brien, economist at NCB Stockbrokers. "Because of the degree of distortion due to those factors, it's nothing we should get too steamed up about," he adds.

He notes, for example, that the cost of clothing and footwear was down 8 per cent in January compared with a year earlier.

While the oil price increase should cease to have such a pronounced effect on the consumer price index, tobacco will remain a factor until next year while mortgage costs are also set to go on rising.

As a result, most analysts expect inflation to continue to tick higher over the coming months, peaking around 4.5 per cent some time around the middle of the year before falling back in the second half.

But some are concerned that the high rate of headline inflation could have knock-on effects in other areas such as wages. IIB economist Mr Austin Hughes says wage demands typically include a cost of living adjustment and that high inflation increases the likelihood of a continuing acceleration in wages going forward.

"The current inflation trend suggests the near inevitability that wage inflation will be much higher in the coming year than the 5 per cent envisaged in the pay deal," he says.

Additionally, there is concern in some quarters about the high level of services inflation - running at an annual rate of 5.8 per cent in January and its impact on competitiveness.

Meanwhile, economists will be keeping a close eye on the impact of December's give-away Budget, particularly whether it acts as a further stimulus to spending, something that will only become clear from April.