The latest inflation figures show that consumer prices last month were four per cent higher than one year earlier. In a matter of months, it appears, Ireland has moved from being one of the low inflation members of the EU to the State with the highest rate of price increase. Forecasters warn that the inflation rate is likely to pick up further over the coming months.
To what extent does the pick-up in inflation threaten the economy? There is no straightforward answer. The key question is whether a high inflation rate becomes ingrained in the economy through high wage increases and further price rises. If this happens, then future growth prospects could be seriously impaired.
To some extent, a pick-up in the rate of inflation is no surprise in a fast-growing economy. Strong consumer demand would normally allow retailers and those providing services to increase prices. A fast-growing economy typically creates shortages of labour and rising costs for other inputs to business, which put upward pressure on prices.
These factors are at work in Ireland. However, other developments are playing a more central role in fuelling inflation. These include the weakness of the euro - which is pushing up import prices - the increase in excise duty on cigarettes in the Budget and rising international oil prices. Unfortunately, the euro is not yet showing any sign of recovering and oil prices look set to remain firm, offering little hope of an easing in the price of imports in the short term.
A gentle pick up in inflation could help to slow economic growth to a more sustainable pace, which would be no bad thing. However, there is a danger of a more rapid rise in prices, which could have a more severe impact on growth. The wage increases agreed as part of the new national programme - which will work out at five to six per cent per year - can be justified in an era of strong growth, soaring productivity in many parts of industry and rising profitability. But increases above this level would run the risk of seriously undermining competitiveness.
Already some trade union leaders are saying that the negotiated increases under the new agreement may not be enough. Meanwhile the latest pay claim from Dublin Bus drivers shows that there is no sign of a slowdown in the escalating pay demands in parts of the public service. If these wage pressures build, and we head into an era of unrest and soaring costs to business, then growth could slow quickly. In turn, the high level of borrowing - particularly to fund house purchases - leaves the economy exposed in the event of such a downturn.
The Taoiseach has promised that the Minister for Finance, Mr McCreevy, will do everything possible to tackle inflation. However, policymakers here have limited scope to act, particularly as interest rates are now set by the European Central Bank in Frankfurt. It is imperative, however, that the terms of the new national agreement be adhered to and that yet another round of inflationary pay increases does not get underway in the public sector. If this happens then the economy - effectively now a region in a larger euro zone - will suffer a sharp loss of competitiveness and growth could slow rapidly.