The inflation rate has risen steadily over the past 18 months, reaching 7 per cent last month. Fortunately the rate, as measured by the consumer price index (CPI), may now have reached its peak and should decline significantly in the months ahead. However, the economy remains prone to serious inflationary pressures, many of which are not directly measured by the monthly CPI figures.
The main reason for last month's rise was higher interest rates, which show up in the housing component of the index, as do increasing rents. The annual rate should decline significantly over the coming months. The sharp rise in tobacco excises, introduced a year ago as a Budgetary measure, drops out of the annual comparison from this month. The VAT cut announced in the Budget will also help, as - provided it is sustained - will the fall in the price of crude oil on world markets.
The annual rise in the CPI should fall below 6 per cent next month and continue to decline in subsequent months. How far the rate will fall will depend to a large extent on international energy prices and the trend in the euro. Interest rates will also play a part. It now appears that after a succession of increases, the European Central Bank will announce no further moves in the early part of next year. It is even possible that the next move in ECB rates could be a cut.
However, the consumer price index is just one measure of inflation. It does not include house prices, which are likely to continue rising next year, helped by the boost to disposable income delivered in the Budget. The debt being built up by borrowers - and the exposure being taken on by lenders - could be a point of serious vulnerability for the economy in the event of a sharp international downturn, or of some kind of collapse in the US technology sector. Despite a string of profit warnings from big technology companies - most recently Microsoft - a serious downturn in the US still looks unlikely, although it remains a possibility.
Upward pressure will also remain on wages, with many employees receiving increases way above the terms of the Programme for Prosperity and Fairness. Rising wages in part reflect employees' share of the wealth created by recent strong growth. But the risk is that these pressures may cause wages to rise too quickly, damaging the competitiveness of industry at a time when the outlook for international growth is uncertain. Wider and more imaginative use of profit and gain-sharing agreements can help to reward employees, while retaining some flexibility for the employer. And new approaches are needed to determine appropriate ways of paying people in non-traded areas of the public service, which - as in the private sector - must tie increases to improved productivity.
Over the next year, therefore, we may see a gradual easing of inflationary pressures across the economy, although dangers remain if international conditions are worse than anticipated. In the longer term, the best way for the Government to tackle inflation is to increase competition in all sectors of the economy. Competition has led to falling prices in areas such as airfares and telecommunications. Many other areas remain to be tackled.