Will the cost of living crisis come to an end?

The expectation is that over the coming months the rate of inflation will fall quite rapidly, as the energy price increases that fuelled high inflation have tailed off.

Indeed, with headline energy prices significantly below last summer, over the next six months there may actually be a reduction in the cost of some forms of fuel. However, a modest price fall would still leave energy price levels well above what they were two years ago. As a result, most people will still be worse off than they were in 2021.

A reduction in wholesale energy prices, especially of gas and electricity, may be slower to pass through to consumers than we might expect. This need not necessarily mean profiteering on the part of utilities, though that, of course, can still be a significant factor.

Because of the recent energy price crisis, some of the intermediaries in the Irish market may have taken fright. Their previous policy had been to either buy gas on the international market when they needed it, or to fix the gas price just a few months ahead with their suppliers.

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This contrasted with the practice in some international markets where people agree a fixed price for gas with key producers many years ahead.

Once inflation starts, there is the danger that everyone will get in on the act, and try to raise their prices and wages

The result of buying mainly at short notice was that, as soon as the wholesale price of gas rocketed upwards last spring and summer, the costs for Irish energy suppliers also dramatically increased. In turn, with a short lag, suppliers passed on the price increases to consumers.

The dramatic spike in energy prices last year has been a shock to us all. So, like borrowers who fix their mortgage interest rate for a period to insure against sudden jumps, some suppliers are likely to have locked in the future price of energy purchases for the coming year. If they did this at a point where the price was higher than today, then – even if they don’t raise their profit margins – the energy price charged to consumers may be slower to fall in line with falling wholesale prices than it was to rise.

[ Cost of living: One-off welfare payments being considered as part of Government package ]

[ Cost of living: More than a million people in Ireland struggling to make ends meet ]

Gas prices are more likely than oil prices to be slow to fall when wholesale prices decline. This is because, with the exception of aviation fuel, the wholesale market for oil is one where buyers rarely seek to agree a fixed price in advance. However, both in Ireland and across Europe, we have limited information across wholesale energy markets on the extent to which buyers are fixing prices ahead, and for what length of time. Such information would be helpful, to understand how fast energy prices should fall.

Of course, energy costs are only one element of the inflation surge that we have seen. Higher fuel bills raise the cost of production of other goods and services, particularly in energy-intensive sectors. But once inflation starts, there is the danger that everyone will get in on the act, and try to raise their prices and wages.

To date the experience both here and across the EU has been that prices, other than energy, have been slower to accelerate. While wages are rising more rapidly than in recent years, they are rising at less than the rate of inflation. In time, when the current problems abate, rising productivity will see a return to real wage growth.

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Compared to the 1970s oil price crisis, right across Europe there is less pressure on inflation from home-grown sources. Therefore the European Central Bank may be able to bring inflation down to its target rate of 2% with limited further major increases in interest rates.

Although inflation may be moderating, nonetheless most people in Ireland are worse off than they were a year ago. This poses a challenge for Government. The 2023 Budget made major provision to moderate the impact of the crisis on households. Some of this support will run out in the spring, although the major social welfare elements, designed to protect the most vulnerable, will remain in place.

The economy remains close to capacity – it is not short of spending power. Unlike in the rest of Europe, Irish people continued to save at an exceptional rate well into the autumn. Under these circumstances, continuing Government financial support for the population at large, rather than for the most vulnerable, is not warranted.

That means restoring the VAT rate to the pre-pandemic level and returning excise on motor fuels to normal, reflecting the costs to the environment. This will incentivise lower emissions from transport. Additional support should be reserved for the most vulnerable.