A surprising fail n inflation rates in January seems to contradict the Bank's annual policy statement flagging the financial dangers of an overheating economy, writes Jane Suiter

By JANE SUITER

THE unexpected fall in the inflation rate to 0.9 per cent in January came as a surprise, particularly as the economy is performing so strongly.

The Central Bank may regret that it chose the day the inflation figures were published to bring out its own annual policy statement, which contained a stern warning about the danger that inflation could accelerate as the year goes on.

The Bank is worried about the rapid growth in borrowing from banks and building societies and the impact on areas like house prices. But in the light of the inflation data and the planned move to EMU, its implied threat that it would consider higher interest rates if the goal of low inflation was threatened rings a bit hollow.

The inflation figures must be treated with some caution. This is the first time the CSO has released monthly data, so there are no comparable figures for January, 1996. As Dr Dan McLaughlin, chief economist at Riada Stockbrokers said, there is thus no way of measuring the impact of the January sales last year and coming up with a valid comparison.

January sales are likely to have reduced the January inflation rate by between 0.4 per cent and 0.6 per cent. In addition, the increase in petrol and tobacco in the Budget will add between 0.2 and 0.3 per cent to the consumer index in February. This leaves an underlying real inflation level of around 1.7 per cent to 1.9 per cent.

Even so, the rate is still remarkably low for an economy growing as strongly as Ireland's. The level of prices actually fell by 0.5 per cent in the two months to mid-January, leaving prices then just 0.9 per cent on average higher than they were at the closest comparable measure - mid-February, 1996.

The main contributor to the fall in prices since November was the clothing and footwear category, which dropped by 8.3 per cent.

Most of this fall is likely be the result of post-Christmas sales, although there has been a longer term decline over the past two years. Durable household goods - washing machines, fridges, TVs and the like - also posted a large decline of 2.1 per cent from November and 1.2 per cent from February.

It thus appears that any inflationary pressure which was expected as a result of sterling's appreciation had yet to show itself.

The inflation figures are calculated slightly differently on the basis of comparisons for the EU Maastricht Treaty and qualification for the single currency. On this basis, inflation has increased by 1.1 per cent since February 1996. Prices have been static since last August and have fallen by 0.5 per cent since November.

The EU measure excludes about 11.5 per cent of all items which are included in the consumer price index. Some of the more important elements are mortgage interest repayments, house and motor insurance as well as expenditure on education and health.

Mr Donal Murphy, the head of the CSO, said he hoped that education and health would be included in the EU index before this September.

On the basis of the latest figures, there can now be little doubt that Ireland will satisfy the inflation criteria for the single currency. Unless unforeseen factors leap into the equation over the next few months. Ireland appears to be firmly among a group of low inflation countries.

Against this background it seems a little over the top for the Central Bank to warn of possible rate hikes.

But according to Mr Kevin Daly, treasury economist at Ulster Bank, given the worries over credit growth and the rapid expansion of the economy, the Bank's statement was surprisingly positive about the inflation outlook.

The Bank noted that the 2 per cent appreciation of the trade-weighted index last year made a "substantial contribution" to controlling inflation.

The Bank is very unlikely to be in a position to deliver on its threat to increase interest rates if further worries emerge. Although the strength of the economy would normally warrant a rate rise, the pound's position at the top of the ERM grid would make it difficult as could push the pound over its 15 per cent limit.

The Bank is thus likely to hold interest rates at current levels for as long as possible, but pressure for them to fall may become irresistible as the year goes on.