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Inflation is back with a bang but how long will it stick around?

Cliff Taylor: There are several reasons to be nervous about the outlook

Reopening economies have pushed up energy prices, where supply problems – notably in the gas market – have also been a big facto Photograph: iStock

Next week fresh official figures will show inflation here running at around 5.7 per cent. This is the highest rate since late 2000, when Bertie Ahern was Taoiseach, Bill Clinton was visiting at the end of his presidential term and Westlife has just had their seventh number one.

Before that, the last time inflation exceeded current levels was in 1985 when Garret FitzGerald was taoiseach and Bob Geldof organised Live Aid.

They were different eras and inflation is now a strange and almost unknown visitor, which everyone expects will leave before too long. But while the inflation rate will almost certainly ease from current highs, there is now a real risk of it remaining stuck at higher levels for a period, with significant economic and political implications.

There is a major debate over this in the US, where the latest inflation has hit 7 per cent.The pandemic has up-ended a lot of things. And one of the results has been a surge in inflation. Consumers have increased demand for goods as they started spending again, at a time when supply lines were messed up by Covid-19. The result has been higher prices.

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The big fear in business, sources said this week, is that these price levels are now the 'new normal'

Reopening economies have pushed up energy prices, where supply problems – notably in the gas market – have also been a big factor. And Covid-19 has also limited the supply of workers in some sectors, putting upward pressure on wages. The belief has been that these pressures will ease as the year goes on. But will they?

The single biggest driver of higher prices has been energy costs, responsible across Europe for half the surge in the inflation rate. Oil prices have jumped – production had fallen early in the pandemic and shortages then emerged. Gas prices have also shot higher.

Reduced supplies from Russia, down 25 per cent year-on-year in the final quarter of last year, are a key factor. Wholesale gas prices have gone from €16 per megawatt hour before the pandemic to €80 now and markets are only signalling a limited fall this year.

The Ukraine situation remains a key risk. Gas is used to generate half of all Irish electricity and so prices have shot up here too.

Energy costs

The big fear in business, sources said this week, is that these price levels are now the “new normal”. And households face the same pressures. Figures compiled by bonkers.ie show increases of between €300 and €1,300 a year for household gas and electricity bills since prices started to rise in October 2020.

And of course many households get more than one bill. Many will be facing energy costs that are 40 per cent to 50 per cent higher than prepandemic levels – and winter electricity and gas bills will be a shock.The Government’s wheeze to give people €100 off their winter bills seems irrelevant.

There are long-term factors at play here, too. In a speech this week, ECB executive board member Isabel Schnabel spoke about the green-energy transition and the forces pushing fossil-fuel prices higher. She also referenced EU and government policies including a withdrawal by big investors from supporting fossil fuel production. Investing in fossil fuels is not a good long-term bet now – and this affects supply and thus keeps prices high.

Indicators show some easing of supply-chain pressures worldwide, but this will be slow and crunch points remain

Consumers and businesses face getting caught by persistent rises in fossil-fuel prices before cheaper, greener energy comes on stream in sufficient quantity, she warned.

The picture is complicated by the tensions in the gas market which is a key part of the planned energy “ transition”, designed to fill the gap as more polluting fuels are phased out. In Schnabel’s words, “we risk facing a possibly protracted transition period during which the energy bill will be rising”.

And there are a few other reasons to be nervous about the inflation outlook. Indicators show some easing of supply-chain pressures worldwide, but this will be slow and crunch points remain. And many companies are now focusing on safer, less complicated supply chains closer to home, even if this costs a bit more and means less product choice. Together with the impact of higher energy prices, these costs will flow through to consumers.

And while jobs markets across the industrialised world are affected by Covid, the impact is magnified in Ireland by the huge demand for employees in a whole range of sectors from tech to pharma, professional services and across hospitality, which means wages are being bid higher.

One observer pointed to the 17 per cent rise in income tax receipts last year versus a 10 per cent rise in the numbers at work – the gap can only be explained by higher earnings. CSO data shows weekly earnings up by more than 5 per cent year on year.

Unprecedented situation

And a survey of the Irish market this week by recruiter Morgan McKinley refers to an unprecedented situation, with shortages driven by a lack of international mobility and by many people reassessing where and how they work.

They forecast a 5 per cent to 10 per cent rise in earnings in many sectors this year and a 15 per cent to 20 per cent jump in certain niche areas. Wage increases should moderate as these once-off Covid impacts work their way out, the recruiter says, but it will take time.

It is impossible to say, looking a year or two out, whether the era of low inflation is just being interrupted by Covid-19, or whether it is now over. There have been longer-term forces holding inflation down which may again, in time, dominate.

But the price level – already relatively high in Ireland – is now certainly getting a significant upward shock. The end of Omicron will lead to another surge in consumer demand, fuelled by pandemic savings. For now, at least, inflation is back with a bang, with big implications for politics as the cost of living rises in a way we have not seen in many years.