The Government has picked a bad time to push up inflation, argues Cliff Taylor, Economics Editor

The Irish rate of inflation will average more than twice the likely EU rate next year - and in the early months of the year is set to be three times the rate of our European partners.

The combined impact of the Budget and the increase in road tax will add almost one percentage point directly to the consumer price inflation rate next year. Most economic forecasters now anticipate that inflation will average close to 5 per cent next year - compared with an expected EU average rate of 2 per cent or less. In the early months of next year, the impact of the Budget measures will be to push the inflation rate temporarily to 6 per cent.

The Government forecasts are that the inflation rate will ease gradually after next year to 3.5 per cent in 2004 and 2.6 per cent in 2005. However, if high inflation becomes embedded in the economy through a high level of wage increases, then the expected gradual decline in inflationary pressures will not happen. Or if they do, it will be because a loss of competitiveness pushes up unemployment and slows growth.

Irish inflation has gone through two phases in recent years. First, in the early years of the "Celtic Tiger" it remained low, mainly because there was plenty of slack in the economy. Between 1997 and 1999, inflation averaged 1.8 per cent.

In phase two - when the economy started to get close to full employment - the inflationary pressures kicked in. Between 2000 and 2002, inflation has averaged 5 per cent. Some economists argued that this was inevitable and would help to ease growth back from unsustainably high levels.

Now, however, the Government has pushed up inflation at a time when the economy is slowing. This will put a damper on growth in two ways. First, higher prices - combined with the non-adjustment of the tax system for inflation - will lower the spending power of consumers. Forecasters believe that disposable incomes may rise by little more than 1 per cent next year in real, inflation-adjusted terms.

Second, higher inflation damages competitiveness by adding to wage demands. The Minister for Finance, Mr McCreevy, has called on those negotiating a new national agreement to act responsibly. However, at the same time he has budgeted for a 10 per cent increase in the public pay bill, twice the expected inflation rate.

It is inevitable that, if the pay talks get under way in earnest - either nationally or at a local level - this will add to pay demands in the private sector.

Interestingly, in Belgium a "health index" - consumer prices excluding alcohol, petrol and tobacco - is used to index public sector wages. In the current environment, the trade unions here would probably take a sceptical view of any similar arrangement.

However, there is no gainsaying the depressing impact that higher inflation will have and the fact that it could leave the economy cruelly exposed in the event of an unexpected economic downturn. With the prospect of war in Iraq - and the consequences for oil prices - and the German economy flirting with deflation, the Government has picked a bad time to push up inflation here.