Economist warns of deflation

Inflation could fall into negative territory next year if the Minister for Finance holds back on Budget increases on indirect taxes, according to economist Mr Robbie Kelleher.

A slowing economy and a stronger euro have been the main factors driving inflation down to 2.3 per cent last month from 5.1 per cent as recently as February, the Davy economist said in a report on the upcoming Budget.

"If there are no material changes in indirect taxes, the headline year-on-year rate could be down to 1 per cent by February and could easily be negative by April or May," he said.

However, his forecast was dismissed by other economists as "implausible" and "highly unlikely".

IIB Bank's Mr Austin Hughes said the inflation rate was largely at the discretion of the Minister for Finance, Mr McCreevy and his priority was likely to be achieving a low, but stable rate rather than dropping through zero and running the risk of a sharp correction in a couple of years.

"You have to ask if zero inflation makes sense," said Mr Hughes. He said deflation was moving off the economic agenda, with oil prices holding and some momentum in commodity prices. "The only state in the euro zone with zero inflation is Germany and that's because it has no economic pulse."

Bank of Ireland chief economist Dr Dan McLaughlin said inflation was unlikely to fall much below 1.6-1.7 per cent in the euro zone as a whole next year and Ireland was likely to see its rate coming in at around 2.4 per cent.

"I think the economy will be a lot stronger next year, allowing retailers to increase margins somewhat," he said.

He said there were other specific factors driving down prices this year which were unlikely to be repeated, including oil prices and mortgage interest rates.

"Getting close to zero inflation would require the euro strengthening dramatically in coming months and the fact is that the rates peaked last spring," he said.

Apart from inflation, Mr Kelleher also warns about spending. Budget Day social welfare increases are likely to bring the rise in current spending to 8 per cent. While not critical this year, such increases, if continued, "will ultimately have to be financed by higher taxation", he says.