Cliff Taylor: High-price pain for households will linger even when inflation eventually eases

Government once-off measures will help consumers this winter but inflated prices will bite hard when measures peter out

The fight is on to combat inflation. The European Central Bank hiked interest rates by 0.75 of a percentage point this week and the Government here is preparing a massive package of once-off measures to try to help households and businesses through the winter. It is clear that the mood in the Cabinet has changed since the recent exchequer returns showed a €6.3 billion budget surplus at the end of August – and TDs started to get it in the ear from constituents getting higher energy bills. The likely size of the package of once-off payments for 2022 – and possibly early 2023 – is now rising almost by the day. Budget Ministers Paschal Donohoe and Michael McGrath might as well run up the white flag on this one and focus on trying to control what happens in terms of permanent budget measures, because they are what costs in the longer term.

There is a political imperative here. The budgets of many households will, when the higher bills start to arrive in October and November, be stretched beyond breaking point. Meanwhile, the viability of many businesses is starting to come under threat. Marry that with a massive budget surplus and you have only one outcome – the spending of vast amounts of money. Last weekend, the cost-of-living package of once-off measures looked set to exceed €2 billion – now it looks more likely to be €3 billion or more. By next weekend, who knows?

The Department of Finance will be more worried about permanent commitments – and the risk that some once-off ones may have to be extended or repeated. It was out this week warning for the umpteenth time that the public finances could go to hell in a handcart if corporation tax were to collapse. Which is true of course. And some day this wolf will probably show up. It’s just that no one has the slightest idea when. And the “when” is important when you consider what we might be facing over the next few years.

Volatile and unpredictable

Inflation could, and probably will, ease back significantly next year. Based on the current level of wholesale gas prices, however, this will be after another round or two of energy price hikes which could take household bills significantly higher still and underpin viability problems for many businesses. We just don’t know on this – much depends on the course of the war in Ukraine, and very volatile and unpredictable energy markets. But the key point is this: even when the rate of inflation eases back, the actual level of prices, particularly for energy, is likely to remain way above what it was. Things may not be getting worse, in other words but they may not be getting much better either.

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And there is where we loop back to the Government’s plans. There will be some permanent changes to tax and welfare in the budget, including a significant rise in base welfare rates. But a lot of the cash to support households is going to be via once-off measures – such as a repeat of the energy credit, perhaps extra child benefit and other welfare payments and so on. This will help households through the winter and allow many businesses to survive. But what happens next year when, even if the rate of inflation has fallen, the actual level of prices facing households and businesses may, in terms of energy anyway, remain punishingly high?

This it the political dilemma facing the Government – and it is a much bigger one than the inevitable row with the Opposition about how much cash it will spend on the special measures this year. It is going with the Covid-19 model of helping households and businesses through a temporary shock – but while lockdowns ended, the scourge of higher prices may continue. So the Government needs to keep some cash in reserve in case it needs to do the same again next year. Whatever happens politically, energy markets have fundamentally changed. The nirvana of cheap renewable energy may shimmer in the distance, but we will be some time getting there. In the meantime, households and businesses have to be kept afloat.

Energy markets

The ECB will be happy if the rate of inflation falls back towards its 2 per cent target. That is its mandate. But it is not its job to engineer prices to fall back to pre-crisis levels. That will depend, more than anything, on what happens in wholesale energy markets. The new British prime minister, Liz Truss, has taken a gamble on what these markets will do by effectively committing that the government there will borrow money to bridge the gap between wholesale prices and a guaranteed price cap for consumers lasting over the next two winters.

The market reaction to this will be interesting. What interest rate will they demand to lend money to the UK and what will happen to sterling? But politically it is going to be a factor here and across Europe, especially if prices rise again in a couple of months’ time. If the UK is capping prices, calls for this to happen here too will grow.

So as it unveils its once-off package of measures, the Government needs to think hard. Does it have reserves to do more next year if needed ? We seem to be going through an emergency period when budgets are not set in stone but adjusted through the year. If we put money aside in a rainy-day fund at the end of the year, we may find it is still lashing in March.

Energy prices at anything like current levels will have a fundamental impact on households, businesses and the wider economy. It also has big implications for the public finances. This looks like what we will face for a few years anyway. The inflation rate will, at some stage, be on a sharp downward trend, but that won’t remove the dilemma of high prices.