ECONOMY: After shooting up in December and January, inflation looks set to remain a problem in 2002, economists said yesterday.

Most believe that the steady decline in prices, which began last April, has come to an end and that the upward trend that has emerged over the last two months will persist in the early part of this year as Budget measures kick in.

"In the next month or two, higher drink prices and the increase in the VAT rate could push Irish inflation comfortably above 5 per cent," said Mr Austin Hughes, economist with IIB Bank.

The restoration of the VAT rate to 21 per cent, after last year's cut to 20 per cent, takes effect from today.

Following yesterday's data, AIB Group Treasury said it was revising its consumer price index (CPI) forecast for the full year upward, to 4.0 per cent from 3.8 per cent.

This reflects its expectation that a first quarter rate cut by the European Central Bank is unlikely to materialise and January's higher-than-expected rise in prices.

The services sector, which was the chief culprit for the jump in the consumer price index to 4.9 per cent from 4.2 per cent last month, remains another cause of concern.

Health services posted the biggest rise in January, with prices increasing by 2.7 per cent, as hospital charges and doctors' fees rose.

The cost of education also recorded a 1.3 per cent increase in charges last month while the cost of eating out in hotels, cafes, restaurants and pubs rose by 1.0 per cent and the cost of recreation and culture increased by 0.9 per cent.

Without a hefty drop in the cost of clothing and footwear due to the January sales, the index might have posted a monthly rise instead of the usual seasonal fall.

However, the 11.5 per cent drop in the cost of apparel along with a 2.1 per cent fall in the cost of furnishings contributed to an overall drop of 0.2 per cent in January prices when compared with December.

"The one clear trend that continues to emerge in Irish inflation data is the strong price pressure in non-traded areas of the economy where competition is not all it should be," said Mr Jim Power, economist with Friends First. "This is a key task for the next Government," he added.

On an EU-harmonised basis, inflation fell by 0.2 per cent in January and was up by 5.2 per cent year on year.

Analysts said it was again the highest in the euro area and close on twice the euro zone average of 2.7 per cent.

The Small Firms Association (SFA) said the gap that was opening between Irish inflation and that in Britain, and the rest of the euro zone left the Republic "very vulnerable to a further loss of competitiveness and threatens jobs in 2002".

It warned that the latest inflation figures must not create a frenzy, leading to a wage/price spiral.

"This will benefit nobody in the long term as inflation will simply be driven higher as a result," said SFA director Pat Delaney.