Cost-of-living squeeze could fuel demands for higher wages – Central Bank

There is a risk inflation could overshoot the European Central Bank's target of 2 per cent "in a persistent way", prolonging the cost-of-living squeeze on Irish consumers, an economic letter published by the Central Bank of Ireland has warned.

The letter, which assesses recent inflation developments in Ireland and across the euro area, noted that central banks including the ECB expect the effects of energy prices and supply bottlenecks on inflation to diminish next year.

“ However, competing views suggest that the current high rate of inflation will lead to higher wage demands, and in turn prolong the elevated inflation rate,” it said. Inflation in Ireland is currently running at a 14-year high of 5.1 per cent.

The factors that might contribute to such a scenario include persisting disruption in supply chains and the ensuing impact on wages and inflation expectations, the report said.

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While this is not “ the most likely scenario currently”, monetary policymakers must be alert to signs of an unsustainable adjustment and be ready to act should this occur, it said.

Wider debate

The letter feeds into a wider debate about whether post-Covid inflation could become a serious problem.

For the past decade, central banks have been concerned that inflation was too low. Now, as economies recover from the pandemic-driven downturn, inflation has surged.

US inflation hit a 30-year high of 6.2 per cent in October as food and energy prices surged.

The Central Bank’s paper indicated that energy inflation was the main driving force behind the current upswing in prices here and in the euro area.

It found that energy accounted for about half of euro area inflation in October, which was 4.1 per cent, despite accounting for only about 10 per cent of the HICP (Harmonised Index of Consumer Prices) basket. If energy prices are excluded, inflation in the euro area was around 2 per cent.

While the inflation dynamics in Ireland were similar, with higher energy inflation accounting for a large share of the overall inflation rate, the prices of services here have increased by more and were up 4.6 per cent in the year to October, it noted.

Goods and food

By comparison, the prices of goods and food have increased by just 1.8 per cent.

“Services inflation was therefore the largest contributor to overall inflation in Ireland,” it said.

The letter examines the factors contributing to the recent surge in inflation. “Following the contraction in economic activity due to Covid-19, there was a strong recovery in 2021. This in turn has led to mismatches between demand and supply,” it said.

“Transport disruption and supply chain issues have contributed to sharp increases in the prices of commodities, raw materials and other inputs in production,” it said.

“Price pressures have passed through to consumer goods to some extent. An imbalance in supply and demand for services as sectors reopened has contributed to wage pressures in certain sectors,” it said.