ECONOMICS: Inflation is going to slow down due to external influences, such as the strength of the euro, but that will not prevent the social partners from taking the credit.
The social partners have declared war on inflation. The recently negotiated, but yet to be ratified partnership agreement, Sustaining Progress (now there's a resounding clarion call if there was ever one), devotes all of four pages to unveiling a multi-pronged anti-inflationary initiative. The weapons that will be deployed in this offensive will no doubt include public vigilance, moral persuasion and stern disapproval. One senses that all those little inflationary germs and viruses out there are quaking in terror at the prospect.
The last time I wrote about this subject - inflation, I mean, not the potency of social partnership as a tool of price stability - was in the aftermath of last May's Consumer Price Index (CPI) report. Then, as now, fear stalked the land. The headline inflation rate was running at 4.7 per cent year on year and the core rate, a more meaningful measure that excludes mortgage payments, was running at 5.3 per cent. My view was that the fear (of a 5 per cent-plus inflation rate becoming embedded in the economy, and worse, a wage-price spiral) was overdone, and that the inflation rate was likely to come down again reasonably soon.
I took this view for two reasons. First, the euro had started to appreciate against the dollar and sterling, and this held out the prospect of the currency-induced upward pressure on prices of the previous few years coming to an end and being reversed. Second, domestic labour market conditions had started to loosen and were likely to loosen a good deal further, partly in response to the squeeze on competitiveness implied by a rising exchange rate, but even more so in response to a weakening international economy.
Subsequent events have proved this analysis correct. The strengthening of the euro has greatly reduced the rate of price increase of those goods and services that enter into international trade. Manufacturing output prices, for example, are now falling - down 0.6 per cent year on year in December according to the latest available data from the Central Statistics Office, compared with an annual rate of increase of more than 2 per cent in the early part of last year. By my own estimates, the rate of price increase for internationally tradable goods and services covered by the CPI (excluding energy products and tobacco) was running at just over 1 per cent year on year in January, well down on the 3.5 per cent rate estimated for last May.
Likewise, softer labour market conditions have produced a sharp slowdown in private-sector wage inflation. For example, by September of last year, the rate of increase of average weekly earnings in distribution and business services, a sector that employs more than 640,000 people, had slowed to just over 2 per cent year on year (the equivalent increase in 2001 was 8 per cent). Analysis of the latest CPI data suggests that this slowdown in earnings growth has been exerting a substantial dampening effect on price inflation across a wide range of private-sector services.
Despite all of this, the overall rate of CPI inflation is almost as high as it was last May. The ex-mortgages rate was running at 5 per cent in January, while the headline rate was running at 4.8 per cent. How has this happened?
Well, there have been a couple of flies in the ointment. The first is energy prices, which have risen in recent months in anticipation of war against Iraq. The second - more like a dirty big bluebottle than a common or garden fly - is the impact of the Government sector. It was estimated by the Department of Finance that the indirect tax increases contained in last December's Budget would boost the rate of CPI inflation by the guts of 1 percentage point.
But this is not all. There are many other ways in which Government decisions have boosted the CPI in the past couple of months. Health costs have risen on the back of increases in hospital charges and changes to the drug payments scheme. There have also been increases in local authority rents, in motor tax (famously not announced on Budget day), in TV licence fees and so on. I haven't gone to the trouble of doing the sum meticulously (maybe the social partners should), but I reckon that the total effect of all increases in taxes and charges implemented by the public sector over the past couple of months has been to boost CPI inflation by about 1.5 per cent.
Two points about this. The first is that the requirement for these public-sector imposts would have been a good deal less if the Government were not providing for an 11 per cent increase in the public-service pay bill this year, including €565 million for benchmarking. The second is that most, if not all, of the impact on the CPI has been felt at this stage. This means that, as the year progresses, the inflation numbers will be increasingly dominated by factors exerting a moderating effect. These factors are likely to include not only those that have already been at work - euro strength, a weak global economy and a softer domestic labour market - but also, assuming a near-term resolution of the Iraq affair, a sharp fall in the price of oil.
All things considered, by the turn of the year the inflation rate could be in the 2-3 per cent range and heading lower, as Robbie Kelleher of Davys expects. If it is, it will have precious little to do with the social partners' offensive, which is being launched after the war has been won. Of course, that won't stop them claiming the credit and, irony of ironies, trumpeting it as another great success for the partnership process.
