Rising labour costs the main inflationary risk, Makhlouf says

With energy prices falling, labour costs will be the dominant driver of core inflation over the next two years, Central Bank governor Gabriel Makhlouf has said.

In an address at University College Cork, Mr Makhlouf said the Irish economy had displayed resilience throughout “the overlapping shocks” of Covid-19 and the onset of the war in Ukraine but had “shifted on to a slower growth path in line with its current medium-term potential”.

He said inflation had fallen significantly over the course of 2023 and was continuing on a downward path.

“The effects of the initial commodity price shock have faded and the secondary impacts remain relatively contained, despite supply pressures in parts of the labour market still being evident,” he said.

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“As the momentum of domestic economic activity ebbs, and the effects of tighter monetary policy both at home and abroad continue to materialise, the process of disinflation is expected to proceed at a more gradual pace over the next two years,” he said.

Noting the European Central Bank’s recent decision to keep interest rates unchanged, he said the past rate increases were continuing to affect the economy. While ECB policymakers did not signal a change in its restrictive monetary stance at its January meeting, markets are betting that the rapid fall in inflation over the last year will force a pivot in the coming months.

A big worry for policymakers has been the rate of wage growth, seen as the main reason for elevated price growth in the services sector.

Mr Makhlouf has praised the latest public-sector pay deal, which will see civil servants getting pay increases of 10.25 per cent over 2½ years, saying the agreement struck “the right balance between catching up with inflation without exacerbating the problem”.

In his speech, the governor outlined Ireland’s vulnerability in the face of recent geopolitical tensions and the deterioration in trading relations.

“As a small open economy with an export-led growth model, the Irish economy is more exposed than others to negative external shocks arising from reduced global trade integration,” he said.

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