There has been much talk about the re-emergence of inflation since the beginning of this year. While the recent falls in the pound are likely to feed through to higher prices, the talk of almost double-digit rises is likely to be exaggerated. At the same time, however, it would be naive to assume that the inflationary dragon has been slain.
It is true that the pound fell significantly last year and yet there were few, if any, signs of an inflationary pick-up. Nevertheless, the recent fall of 3 per cent on a trade-weighted basis has ignited fears as it never did last year.
It would appear that until very recently most retailers were assuming that the currency depreciation could be short-lived. Thus many absorbed the losses or their suppliers did. The difference now is that many only covered their currency exposure up to three months ahead and are now running out of time. The other is that the fall in the currency is seen as a long-term move which will not be reversed over the coming months.
This is because the depreciation is nothing to do with the economy and is simply a reaction to our entering monetary union and thus the falls against the deutschmark are unlikely to be reversed.
On the other hand, many retailers are expecting sterling to fall off sharply over the coming year and have pencilled in long-run average values of around DM2.50. According to Mr John FitzGerald, research professor at the ESRI, many may not implement price rises because of competition from Irish retailers and will sit on the losses for a little longer until sterling turns down.
He also believes that many British firms are acting on their belief that the long-run equilibrium value for sterling is around DM2.50 and they are prepared to wait for the expected fall.
Overall, it would seem almost inevitable that prices will rise over the course of this year, but probably by less than indicated in some of the more gloomy comments of recent days. However, how much this will be and whether it is a long-term trend remains to be seen.
One issue which will be important in this regard is inflationary expectations.
If most people believe that this is simply a once-off rise in prices then the national wage agreement should hold and wage inflation will be held at bay. But, if it is seen as something more far reaching, many may be reluctant to carry on accepting limited wage rises in return for low inflation and tax cuts.
However, as we are joining monetary union there are few firms or investors who will actually believe that Irish inflation could be on an upward trajectory for a number of years.
Individuals are also likely to be consoled when looking at the difference between the headline rate of inflation and the underlying rate which excludes mortgage interest repayments. With interest rates set to decline by as much as 2 percentage points over this year, the headline rate is likely to be far lower than the underlying rate.
If it could be guaranteed that higher inflation would be a short-term phenomenon then it could be argued that the greater danger to the overall economy would be the possible loss in competitiveness from a revaluation which would be permanent, as it would involve locking in to ERM above our existing central rate. Thus there is a strong argument that a revaluation to allay short-term inflation worries would be an overreaction given the long-term implications.
It is also likely that the Asian crisis and the possible global disinflationary environment which Mr Alan Greenspan, the chairman of the US central bank, the Federal Reserve, has warned of will also serve to hold inflation in check.
While we do not have large amounts of direct trade with much of the Far East, many of our imports from Britain are actually originally sourced there and thus should hold price rises in check. One short-term danger from the combination of higher inflation and lower interest repayments is a further boost to runaway prices in assets, particularly housing.
The budget changes which were extremely expansionary in terms of both the overall tax package and reductions in capital gains tax are likely to have kick-started this movement, but the fall off in real interest rates payable on savings could also trigger substantial flows from bank and building society savings accounts into the housing market.
The absence of a revaluation would also highlight this as everyone's savings would be worth less than before in terms of euros.
In fact, the combination of higher inflation and lower interest rates could prove very detrimental to many pensioners and savers. It is even possible that inflation could outpace interest rates resulting in a declining value of many people's savings and a real incentive to borrow more.
The Central Bank is already very worried about credit expansion as well as soaring house prices and will be uneasy with this scenario. According to Mr FitzGerald it is ironic that the Government has been telling everyone to get ready from unions to business and yet implements "wholly inappropriate" fiscal policy itself.
In some ways it may actually be strong asset prices which have the greater potential to undermine Partnership 2000 through higher wage demands and thereby upset future economic progress, rather than some additional sterling-imported inflation which has been the main focus of concern over recent weeks.
