News that the inflation rate remained unchanged at 6.2 per cent in September is welcome. However the respite may only be temporary. Many analysts had feared a higher rate, but a combination of factors held back at least some price rises last month.
The Central Statistics Office recorded prices which applied on September 12th - before many petrol stations raised pump prices and before mortgage lenders applied the latest European Central Bank interest rate increases. The Minister for Finance, Mr McCreevy, yesterday recognised this, when he said that inflation is likely to pick up again next month. The outlook remains poor. The continuing weakness of the euro, evident again yesterday on the international markets, is still posing a threat to the inflationary outlook, as it pushes up the price of imports. The rise in oil prices will also affect international inflation and economic growth. Crude oil is still trading at levels last seen when Iraq invaded Kuwait in 1990. This is already feeding through to inflation across the euro zone, with prices rising at an annual rate of 2.8 per cent in September from 2.3 per cent in August.
This pick-up in general euro-zone inflation may prompt further interest rate rises from the ECB. In the short term, this would further push up inflation here, as mortgage costs feed into the consumer price index. However, over the medium term, higher borrowing costs should reduce growth and thus ease inflationary pressures in areas like the housing market.
Higher inflation is causing pressure on social partnership. Employees are seeking wage rises to compensate for higher prices. The danger is that higher wage costs might become built into the economy, leading to a sustained loss of competitiveness as Irish wages grow faster than those of our competitors. This would leave the Republic increasingly vulnerable in the event of an unexpected economic shock, or a rise in the value of the euro.
Mr McCreevy has promised that an anti-inflation package will be at the heart of December's Budget. But that is likely to prove very difficult. The Government can do little to influence the value of oil prices, or to affect the level of the euro. It could consider lowering some fuel excise duties or VAT. This would reduce the measured rate of inflation - thus taking some of the pressure off short-term wage demands - and help the sectors worst affected. It would, however, be only a short-term measure.
Rising inflation means that the Government must show restraint in deciding the overall amount of money to be released into the economy through Budgetary measures. And Mr McCreevy should ensure that the main benefits from any tax package are aimed at lower and middle-income groups, which would be less inflationary than giving big gains to higher earners.
But the ultimate policy approach must be to encourage competition in all sectors of the economy. This will require a determination by the Government to take on vested interests in a number of sectors and to equip the Competition Authority to take an active approach. Otherwise the risk of an uncomfortably high rate of inflation becoming embedded in the economy will increase.