We're fast becoming used to the ritual. Another month, another disappointing inflation figure. In only two of the past 21 months has Ireland's annual inflation rate fallen. Each figure prompts a litany of special factors that seek to explain the latest aberration. Each month forceful arguments are presented to support forecasts that point towards tumbling inflation in the future. Such forecasts will eventually prove correct. Indeed, there is a reasonable prospect that the headline inflation rate will begin to ease fairly soon. Unfortunately, a protracted period of higher than expected inflation has already begun to adversely affect the Irish economy. Rapid increases in prices have fundamentally altered perceptions as to what a fair return should be, whether that return relates to profits, wages or social welfare payments. Because high inflation has altered the expectations of Irish households and businesses, it risks setting domestic costs on a trajectory that could quickly become unsustainable in what looks an increasingly difficult international economic landscape. Irish inflation will ease back. Unfortunately, it is not clear that process will be painless.
Ireland is by no means unique in experiencing higher inflation of late. Inflation worldwide has been edging up because of exceptional factors. Pressure on food and energy prices across Europe means that inflation is now above the European Central Bank's target of less than 2 per cent in every state in the euro zone.
The impact of the foot-and-mouth crisis and BSE has had a spectacular impact on food prices. In the most recent Irish data, lamb prices were nearly 30 per cent higher than a year earlier. In addition, energy prices have remained stubbornly high. With the peak motoring season in the United States approaching, there are risks that petrol prices could move even higher. Although these factors could cause problems for a couple of months, a less threatening balance between demand and supply in food and energy markets should emerge before long.
More fundamentally, substantially weaker global economic activity should begin to exert substantial downward pressure on inflation abroad later this year. Unfortunately, this likely improvement may not translate fully into lower Irish import costs because of the continuing frailty of the euro on international currency markets.
Lower inflation elsewhere will bear down on Ireland's headline inflation rate. Unfortunately, poor Irish inflation also reflects several uniquely Irish factors. Food prices rose by 7.7 per cent in the year to April, the largest increase since April 1984. This is not entirely due to foot-and-mouth and BSE. The price of biscuits and baby food increased at double-digit rates, partly reflecting higher import costs, while the cost of eating out was also substantially higher than a year ago because of domestic cost pressures. Across a broad spectrum, price pressures persist. For example, the major contribution to higher housing costs came from higher mortgage repayment costs - up a staggering 46 per cent on the year because of higher interest rates and larger debt burdens.
However, a 34 per cent jump in local authority charges, a near 15 per cent rise in rents and a 9 per cent increase in house insurance costs serve to demonstrate the range of "shelter" costs now rising rapidly. The evidence across other insurance categories, car repairs, medical, educational and childcare costs, paints a similar picture as buoyant demand and impediments to supply produce a predictable outcome. Another feature of recent data has been a rebound in drink prices. Again, this was scarcely surprising as temporary price freezes offered only superficial relief. In summary, although one can identify "special" factors boosting prices in many sectors, the broad picture is of an economy under significant strain.
Many believe that the emerging downturn in the global economy will remove this strain. Unfortunately, the downturn will not directly hit the relevant sectors. The available evidence does not suggest capacity constraints are having a severe impact in the high-tech or other export sectors. To assume a painless and rapid transfer of resources from these areas to the more congested areas of the economy, as many do, requires a considerable act of faith in the flexibility of the Irish economy.
A particular concern is that this transfer must occur against a backdrop of heightened inflation expectations and an increasingly fractious debate as to how the spoils of the recent boom should be divided. In this context, an emerging norm of 30 per cent pay demands as a means of "inflation-proofing" earnings doesn't bode well for Irish competitiveness.
As a result, it is possible that the eventual adjustment to lower Irish inflation could entail a notably poorer jobs market.
Certainly, in a global economic downturn we should quickly discover how entrenched current price pressures are and how deep-rooted the economic improvement of the past decade has been. As the renowned investor Warren Buffett put it, "it's only when the tide goes out that you learn who's been swimming naked".
