The big rise in inflation rates worldwide has stirred central banks into action. The massive pandemic emergency programmes of government bond-buying are being wound down and there are the first moves to increase interest rates.
Despite the economic threat of the Covid-19 Omicron variant, the Bank of England increased its base rate from 0.1 per cent to 0.25 per cent last week, while the Federal Reserve Board, the US central bank, said it expects three interest rate increases next year. The European Central Bank is likely to be more circumspect, but it too will come under pressure to raise interest rates if inflationary pressures do not ease.
The jump in the rate of inflation across major economies has taken central banks by surprise – and more is to come in the early part of next year. The Irish inflation rate rose to 5.3 per cent in November and the euro zone average is close to 5 per cent. The inflationary pressures are coming from a number of factors – higher energy prices, problems in supply chains and the bounce back from full lockdown in the first half of 2020.
Some of these factors will ease later in 2022, but already the inflationary spike is more sustained than expected. And there are risks that it will persist. If wages also increase in response, or supply chain problems persist, then inflation could remain relatively high. The impact of Omicron is unclear – it is likely to dampen demand in some sectors, but could also hit supply chains.
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This has a number of important implications for Ireland. The backstop of the ECB buying Government bonds in the market will slowly be removed. This is likely to lead to some increase in the cost of State borrowing and will certainly lead to a new focus from investors on how states manage their national finances.
For personal borrowers, interest rates may drift upwards over the next few years, though by how much is hard to judge. Meanwhile, financial markets may get edgy as this plays out. Inflation and the cost of living will be one of the stories of 2022.