Spectre of inflation returns to haunt Irish households

Irish households are facing the biggest cost-of-living squeeze in decades and it’s likely to get worse before it gets better. Inflation here is now running at 5.5 per cent, its highest level since April, 2001.

Almost everything is more expensive than it was a year ago: energy, accommodation, food, travel, insurance. Energy bills alone are expected to rise by up to €1,300 this year.

This will have a corrosive effect on household budgets. Rising prices hit poorer households harder as they spend more of their income on necessities. If that wasn’t bad enough, house prices, the perennial bugbear of the Irish economy, are steamrolling forward again, rising an annual rate of 14 per cent. Make no mistake, 2022 is going to bite financially.

The irony is that the global surge in inflation is partly the unintended consequence of two very positive developments; government supports and vaccines.

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The rollout of financial supports to shore up workers and households affected by the crisis has facilitated a quicker than expected rebound in demand for goods and services, which has in turn triggered price hikes across the economy.

The rapid development and rollout of vaccines (at least in rich countries) has accelerated this rebound.

Another, perhaps less positive, reason for the current surge in prices relates to the globalisation and complex international supply chains that underpin modern production processes.

Since the 1990s businesses have been sourcing parts in cheaper and cheaper destinations – often on the other side of the world – in a bid to keep prices down; in effect exporting inflation that might have occurred in a less liberalised economy. This has come back to bite us hard with shipping and other supply routes now clogged and subject to long delays.

The traditional remedy for inflation, interest rates, are no longer within the Government's gift and the European Central Bank has pledged not to lift them this year for fear such a move will damage recovery. The more reactive US Federal Reserve is expected to adopt three rate hikes this year alone.

In any case, rate hikes take 18 months to two years to work, meaning they would have little impact on the immediate price environment. They also only temper demand and therefore would have no role in cooling inflation emanating from supply chain disruption.

That leaves fiscal policy. Measures such as VAT reductions or energy credits – the Government here is planning a €100 credit to help offset the cost of energy bills – are being considered but they’re unlikely to make much of dent, particularly if energy bills are rising by as much as €1,300.

Coronavirus unwind

And remember government budgets are out of whack because of the huge outlay on wage supports, meaning there is considerably less room for manoeuvre.

The biggest fear for governments is that the current price surge becomes ingrained in system and is longer a “transitory” manifestation of the coronavirus unwind.

One way this could happen is through wages. If wages start rising as workers demand better compensation for the current cost-of-living squeeze that can create a wage-price spiral, leading to a more prolonged period of price growth.

Wage growth in the Irish economy is running at about 4 per cent but there are compositional problems with this measurement as thousands of workers in consumer-facing sectors such as hospitality are not working, skewing the headline number.

Inflation can also be self-perpetuating: if people believe prices are going to go up, they’ll buy now, pushing up demand and prices. Either way, the current surge in inflation is likely to raise the political temperature here with the Government facing calls from the opposition to do something to offset the increase while at the same time trying to rein in coronavirus-strained budgets.