If inflation persists at current levels it could lead to a sharp loss of competitiveness, the governor of the Central Bank, Mr Maurice O'Connell, has warned. He has urged the Government to use budgetary and incomes policy to contain inflation.
Speaking to an Oireachtas Joint Committee on European Affairs, Mr O'Connell said the strong rise in underlying inflation reflected the existence of strong demand and said the economy was more vulnerable than before to overheating.
This was reflected in exceptionally rapid increases in property prices, unprecedented demand for credit, labour shortages, higher inflation in the services sector and chronic congestion in the physical infrastructure, said Mr O'Connell. He said the Central Bank's ability to take corrective action was severely restricted due to membership of EMU. He said interest rates remained considerably below where the Central Bank would consider appropriate.
The Republic was now part of a regime which "may demand from us disciplines to which we are unaccustomed", said Mr O'Connell. "A greater onus is now placed on other factors, such as fiscal and incomes policy," he added.
Mr O'Connell said the Republic was now top of the inflation "league table" in the euro zone. This was due to once-off temporary factors such as the rise in excise duty on cigarettes, higher oil prices and weakness in the euro but that there was a strong rise in underlying inflation.
Mr O'Connell said a strong euro was in Europe's, and the Republic's, best interest. He denied the charge that the European Central Bank pursued an attitude of "benign neglect" or indifference to exchange rates. He said the euro was currently significantly undervalued and he expected it to strengthen in the future.
Mr O'Connell said publishing minutes of Bank council meetings and the voting records of individual members would serve no useful purpose. This could inhibit discussion and possibly put pressures on members to reflect a national viewpoint.
He said a single currency and greater European integration posed a threat to the Irish financial services industry. The future of small stock markets may be in doubt, as investors had a preference for larger markets.
However, Mr O'Connell said he was optimistic the International Financial Services Centre would continue to grow. He said studies for the medium term, undertaken by the Central Bank, suggested the Irish economy had the capacity to grow at a rate of 4 per cent to 5 per cent a year in the medium term.
