If the Central Bank's statement on monetary policy were to be boiled down to one word, that word would be inflation. The bank is noticeably conscious of the risks inherent in a roaring economy and regards inflation not just as a risk but as a likelihood. The surge of the Celtic Tiger has done wonders for employment levels and for the Government's finances but, wholly unchecked, it could sow the seeds of reversal. Holding on to the tiger has to be the Government's priority.
The problem is that the Government and the Central Bank are greatly diminished in their power of influence. The economy would benefit from a slight increase in interest rates, to cool down the spending splurge. But monetary union means interest rates coming down to continental averages and the market is going that way already; a second bank announced lower mortgage charges yesterday. Selective and modest increases in taxation would also slow down the tiger but last month's Budget went for the exact opposite. A stronger pound (especially against sterling) would curb the rising cost of imports but the pound would enter the single currency most effectively at an even lower rate than it is now at. And this too has not been lost on the markets which have driven the pound down to a ten-year low against sterling, the dollar and the deutschmark.
It must be the great paradox of our economic performance that the economy can be surging ahead, almost to the point of overheating, while the currency is tumbling daily. But the markets, as we have witnessed before, are not hung up on economic fundamentals. The critical relationship is that between the pound and the deutschmark. The markets take the view that the pound will enter EMU at a value of 2.41 deutschmarks, a good bit lower than the 2.52 at which it stands this morning. The pound would not have fallen so much if the Minister for Finance had hinted at a higher entry level. But he hasn't. Even though it is the Minister's responsibility, the Central Bank yesterday might have voiced an opinion but it didn't. And the markets will take their cue.
The decline in the pound's value is a mixed blessing. Undoubtedly it will manifest higher prices across a wide range of imports. On the other hand, foreign customers will find Irish exports much cheaper to purchase. This boost to competitiveness should strengthen the economy, particularly in labour-intensive industries where comparatively high wage rates put us at a disadvantage with low-cost countries. Moreover, the pound's decline may be short-lived. Its value against the deutschmark will be fixed but its value against sterling and the dollar will not. Sterling is overvalued and growth in the UK economy is slowing down. The US economy is strong but has peaked - and the turmoil in Asia will do it no good. The pound may fall further against both currencies but a later recovery is on the cards.
The Central Bank is right to be concerned about inflation. Asset values, especially housing, have risen significantly and there is much international evidence that, uncorrected, this can push up inflation and destabilise the economy. Financial institutions increased their lending by 20 per cent last year while a combination of tax cuts and interest-rate reductions this year will encourage even greater spending levels. This time next year Ireland will be locked into monetary union. How the Government handles the economy in the interim may determine how good that union will be for the economy.