ECONOMICS/Jim O'Leary: The latest CPI numbers show that the decelerating trend in inflation is continuing apace.

According to the December report from the CSO, released a couple of weeks ago, the annual inflation rate fell to 1.9 per cent last month, down from 2.2 per cent in November. It was 5 per cent plus as recently as last February.

I predicted as much in this column around this time last year (Moderating factors will flatter new wage deal, February 21st) and also predicted in the same piece that the social partners would claim the credit - they had just launched Sustaining Progress with a declaration of war on inflation.

Actually, the second prediction has also come true. I recently met a social partner who suggested to me that the reason inflation had come down was because the blood-curdling threats from ICTU, IBEC and the Government had put the frighteners on the nation's shopkeepers and service-providers.

Well you can choose to believe that if you want. Perhaps it's your patriotic duty to do so. I prefer to stick with the view that the decline in the inflation rate is due to more prosaic, economic factors, such as an appreciating currency.

In this regard, I am guided by the fact that the euro has appreciated by 20 per cent against the dollar and 6 per cent against sterling over the past 12 months (and by a great deal more if one extends the timeframe back over the last couple of years). Of course, softer domestic demand and a weaker labour market have also helped.

What of prospects for the year ahead? Well, I think the inflation rate is likely to drop further. I say this principally for two reasons.

The first and more important of these is that the effects of the euro's most recent bout of appreciation have yet to register in the prices of imported goods. Given the time lags involved, such effects are likely to take six months or more to become fully apparent.

The second reason is that the 2004 budget will have a much more modest impact on the general price level than the 2003 budget had. This will be evident in the CPI numbers for the early months of the year.

All in all, I think it quite likely that the inflation rate will have fallen to 1 per cent or less by April, and it should not accelerate very dramatically above that mark over the balance of the year.

Despite their ringing endorsement of the war on inflation, this prospect may be something of an embarrassment to the principal employers' groups. This time last year, when inflation was running at 5 per cent, they signed up to a national wage agreement that called for an annualised wage increase of 4.75 per cent - or a cumulative wage increase of 7.2 per cent - over the 18 months to mid-2004. It now looks as if the cumulative increase in the CPI index over the same period will be not much more than 2.5 per cent.

Consequently, the real wage increase consistent with the terms of the agreement looks like being about 4.5 per cent, a fairly hefty rise in a slow-growing economy with increasingly obvious competitiveness problems, and something of a windfall gain for employees.

So, the current wage agreement looks like conferring a windfall gain on those employees who have been paid in accordance with its terms, and looks like expiring at a time of ultra-low inflation. What might the consequences of all this be for a new deal? Well, it seems to me it will be very difficult for the Government to agree anything other than very low single-digit increases for public servants who will not only have harvested a windfall from the basic terms of the current deal but will also have gained substantially from the benchmarking process.

Things are a little different as far as the private sector is concerned. However much of a windfall may have accrued under the terms of the current deal, it will presumably be very hard to persuade the predominantly private-sector unions to agree to very low single-digit wage increases for their members, who have not, of course, benefited from benchmarking.

What about the expedient of providing for somewhat higher increases in the private sector? This would seem to be ruled out on the grounds that it would fly in the face of the benchmarking exercise.

There would not appear to be much point (even by reference to the labyrinthine logic of Irish industrial relations) in raising public sector pay ostensibly to bring it into line with the private sector, and at the same time trying to engineer fresh differentials in favour of the private sector.

Perhaps the scenario that is at hand will create tensions that cannot be bridged by a national wage agreement, in which case the outcome would be a new agreement for the public sector and a so-called "free-for-all" in the private sector. A prospect to worry about?

For some private sector companies perhaps, for example those - a small minority at this stage - with a strong trade union presence. But for most, probably not.

I don't believe there is a compelling reason to suppose that for the majority of firms, labour markets will behave materially differently in the absence of a national wage agreement than they would if one were in existence.

Jim O'Leary is currently lecturing in economics at NUI-Maynooth. He can be contacted at jim.oleary@may.ie