The inflation rate has begun to pick up to worryingly high levels. The December figures published yesterday by the Central Statistics Office - and the evidence from areas such as the housing market - paint a picture of an economy experiencing substantial inflationary pressures. At the end of December, the annual inflation rate was running at 3.4 per cent and if mortgages are excluded, this rises to 4.2 per cent. Many economists are now predicting that the inflation rate this year will average closer to 4 per cent than 3 per cent.
The decision to raise the excise duty on cigarettes by 50p in the Budget had a very strong impact on the latest inflation figures, accounting for almost three-quarters of the monthly increase. A cut in the duty on wine would have negated some of that impact. So what are the immediate risks of inflation continuing to accelerate? Much will depend on the future course of oil prices. A further acceleration would add more pressure in the months ahead.
The other main variable will be the strength of the euro over the remainder of this year. So far there has been little sign that the higher import prices resulting from the weaker currency are being passed on by retailers. But even with the high level of competition in the retail sector, this cannot continue forever. Eventually the price of higher imports will be passed on to consumers. A reversal in the euro's fortunes would go some way to stemming the inflationary tide.
Domestically, the concern now is that higher costs being built into the economy will damage our competitiveness in the long term. Inside the single currency this could result in a slow erosion of our economic performance.
Ireland has moved from having the lowest inflation in the euro zone, just two years ago, to having the highest. This is not good news for the Government in the middle of negotiations for a new pay agreement. The average rate of inflation last year may have been 2.2 per cent but it is the high end-of-year figures which many trade union negotiators are likely to point to, when looking at cost of living increases in a new deal.
It is now vital that profit or gain sharing be a significant part of any new deal to ensure a fair return for employees and protect competitiveness. This means employees can share in the fruits when times are good, while not locking in unsustainable costs in the event of a downturn. This concept also needs to be extended to the public sector, where the Government must deliver on its programme of reform. Without this, there is a danger that excessively high costs could be built into what will be a multi-annual agreement. And that would have serious implications for the longer-term growth prospects of the economy.