Prices falling at sharpest rate in almost 50 years

The Irish economy experienced deflation for the first time in almost 50 years last month as the price of goods and services dropped sharply.

The overall cost of living as measured by the Central Statistics Office (CSO) Consumer Price Index fell 1.7 per cent in January. This dragged annual inflation down from 1.1 per cent in December to -0.1 per cent last month, a level not seen since the second quarter of 1960.

However, the monthly data is a tale of two trends, with prices rising in eight of the 12 categories measured by the CSO. The overall cost of living fell due to the weighting attached to the four price areas showing a decline.

The principal reason for the fall was a sharp drop in mortgage costs, which declined 15 per cent. In the three months to January, declining mortgage interest costs have accounted for two-thirds of the inflation drop.

Homeowners saw repayments fall by €50 to €150 on average as a result of the European Central Bank half-point cut in rates to 2.5 per cent in December. A further cut of 0.5 per cent in January will feed into inflation data for this month.

Consumers also benefited from lower petrol (-4.3 per cent) and diesel (-5.5 per cent) prices last month. Air fares dropped by 9.6 per cent, following a 10 per cent drop in December as global oil prices continue to weaken.

Post-Christmas discounts offered by retailers saw clothing and footwear costs decline 13.2 per cent last month.

Despite the sharp monthly fall in mortgages, fuel and clothing, prices for many Government provided services such as health, education, energy and public transport continue to rise.

Health costs rose 2.8 per cent last month and by 5.8 per cent in the year, while hospital services rose by 10.4 per cent. Over the year education costs rose 5.6 per cent. Increases in bus and rail fares and motor tax saw overall transport prices increase 8.6 per cent in January.

Alan McQuaid, economist at Bloxham stockbrokers, said the fall in prices was the only good news for the Irish economy at the moment and should boost consumer spending. He predicted further falls in inflation in the coming months and sees it declining to -3 per cent this year. However, he said he does not see it becoming embedded as the “global stimulus packages will eventually be inflationary”.

Mr McQuaid added that for the State to remain in the euro, “wages and prices will have to be cut by at least 20 per cent” to restore competitiveness.

Rossa White, economist with Davy stockbrokers, said it was important not to underestimate the combined impact of falling mortgage costs and seasonal factors such as sales.

Having seasonally adjusted the data, Mr White said consumer prices actually increased 0.4 per cent last month, indicating that retailers and service providers “are not actually cutting prices on average yet despite the deep recession”.

“It is not hard to see those businesses that are keeping the price index up: only hospital fees, public transport tickets, insurance and off-licence alcohol prices increased significantly in January," Mr White said. “Two of those are government-administered and the biggest cost is labour: this shows the imperative to get that base down.”

While householders are enjoying declining mortgage cost burdens and may see a marginal increase in purchasing power in sectors where prices are falling, low inflation or deflation means employees are less likely to receive pay rises.

The headline rate of inflation has fallen almost five percentage points in the past seven months from a high of five per cent in June 2008.

Pat McArdle, chief economist with Ulster Bank noted the trend in the insurance sector has changed with the sector showing price increases.

"Dwelling insurance was up 4.1 per cent, health insurance, 19.6 per cent and motor car insurance 3.6 per cent, the largest health and car increases since 2002.

He expects inflation to remain negative right through 2009 and to hit -4 per cent during the year. Mr McArdle also noted no price change for car prices was recorded last month.

"A casual glance at the papers shows massive falls in prices, old and new alike. The CSO, however, have a zero change in prices in January.

"This may well be because they take list prices which are being maintained while cash back and other incentives are common. Had these been captured, the Jan CPI would have been down by more," he said.