Cliff Taylor

Economics Editor

The inflation rate could fall below 1 per cent over the coming months and the average increase in the consumer price index for the year could be as low as 1.3 per cent, according to a new report from Davy stockbrokers.

This will do little to help competitiveness, however, as wage inflation continues to run at 5-6 per cent.

Inflation has fallen surprisingly rapidly in recent months, the broker says. It estimates that the headline annual increase in consumer price inflation could fall below 1 per cent by March/April, with the annual average increase dropping from 3.5 per cent last year to 1.3 per cent this year.

This is well below the Central Bank's forecast of 2.75 per cent and the Department of Finance's Budget Day projection of 2.5 per cent.

While price inflation has been falling, there has been no evidence of a similar slowdown in wage inflation, the report says.

The latest available data suggest wage inflation was running at 5-6 per cent across the economy in the middle of last year.

Given the terms of the national wage agreement and the benchmarking rises for public servants, average wage inflation could run at a similar rate this year.

This will mean that real incomes - incomes after inflation - will rise significantly, boosting consumer demand.

But given the stronger euro, "it also implies that competitiveness in Irish firms will deteriorate very significantly again in 2004".

Figures quoted in the Davy report from the US Bureau of Labour Statistics show that, in 2000, wage costs in Ireland were about two-thirds of those in the US and Europe and three-quarter those in Britain.

The combination of high wage inflation and a strengthening currency has seen these advantages eroded.

At current exchange rates, absolute wage costs in Ireland this year will be on a par with Britain and the US and the advantage relative to Europe has been closed to just 20 per cent.

Overall, the economy is set to improve significantly this year, with gross national product (GNP) set to expand by more than 3 per cent, according to the broker. Underlying trading conditions will improve in most sectors, Davy forecasts, and it should "feel" a lot better than last year.

Rising exports and a recovery in consumer demand should push GNP growth to 3.1 per cent.

Positive factors for this year include the US-led recovery, low interest rates and improving business and consumer confidence.

But significant difficulties are the rising value of the euro and the risk of a downward adjustment in the level of housebuilding, which has been running at a very high rate.