Inflation Accelerates

 

The latest inflation figures show that the annual rate climbed to 4.3 per cent last month, the highest level in a decade. The indications are that inflation is set to rise further in the months ahead, certainly exceeding 4.5 per cent and possibly even reaching 5 per cent. Much now depends on factors outside the control of policymakers here, including the trend of oil prices and the value of the euro.

The latest figures coincided with the publication of a report in Brussels, in which the European Commission again warns the Government about the dangers posed by inflation. The Commission says that Budget policy is inappropriate for an economy showing signs of overheating. It does, however, applaud income tax reform designed to encourage people to take up employment.

The Government - and EU forecasters - are confident that price pressures will start to ease around the middle of the year and that the inflation rate is now close to peaking. For the moment, however, inflation is picking up right across the euro zone; figures yesterday showed the Spanish rate at 3 per cent. This inflationary trend is likely to prompt another interest rate increase from the European Central Bank, either tomorrow, or after its next meeting in a fortnight's time.

Unfortunately, from the point of view of the Irish economy, the upward trend in interest rates is coming too late. If the Central Bank was still in control of borrowing costs, then they would be much higher than their current level. Low interest rates have helped to fuel the boom in the housing market and the related rise in borrowing, factors which would leave the economy here somewhat exposed in the event of an international downturn. Ironically, house prices are not included in the consumer price index.

How concerned should the Government be about the pick up in overall inflation? Its immediate policy options are limited. It cannot influence the international trend in oil prices, where the next important event will be a meeting of OPEC ministers at the end of this month. Nor has it any input into the value of the euro - another key factor, as the recent weakness of the currency has pushed up import prices.

The advice from Brussels to tighten Budget policy is impractical. Very significant tax increases or Government spending cuts would be needed to slow the economy markedly and this is a course of action which is neither politically possible nor economically desirable. That said, the targeting of tax cuts at the higher paid in the last Budget was unfortunate. Giving more to lower earners would have provided a smaller boost to demand in areas like the housing market.

The Government must now ensure, in so far as it can, that the higher inflation rate is not built into the economy for the long term, through a further increase in wages above the rises set down in the new national programme. In particular, it will face a fight to control wages in parts of the public sector. The benign scenario would be if the pick up in inflation modestly eroded competitiveness, allowing economic growth to ease back to a more sustainable path. For the moment, the strong productivity growth of much of industry - and the weakness of the euro - means that the impact of inflation on economic growth is probably limited.