• Irish inflation slips to 5.0%   in January from 5.5% in December but renewed upward pressure likely to be seen in coming months   
• Price pressures still largely a story of surging global energy costs and modest price creep in other areas
• Drop in January inflation prompted by post-Christmas sales price cuts and  drop in air fares both of which are likely to reverse
• Some further policy offset may be needed but should be more targetted
• Critical task is to prevent domestic inflationary free-for-all

Irish inflation eased back to 5.0% in January from 5.5% in December (and on the EU harmonised measure from 5.7%0 to 5.0%. This should be seen as a welcome if likely temporary interruption to the sharply rising trend evident through most of 2021.Inflation should pick up in coming months, with the unpredictable evolution of energy costs determining how far and how fast before easing later in the year.

As the graph below illustrates, the pull-back in Irish inflation in January was not seen in most other economies. However, the graph also strongly suggests that the broader upward trend in Irish inflation through 2021 has to be seen as part of a global increase in price pressures.

The details of the January data are dominated by substantial price cuts in the post-christmas sales that saw the year on year change in clothing and footwear prices drop from +.1% in December to -3.7% last month. This largely reflects the curtailment of sales in January 2021 because of Covid restrictions and is likely to gradually reverse in coming months.

In the same fashion, a 44.9% month on month drop in airfares exerted unusually large downward pressure on the headline inflation rate for January but may reverse materially through the spring. 

These favourable influences more than offset a sharp jump in drink price inflation (to +8.7%y/y in January from -1.3% in December reflecting the introduction of minimum unit pricing for alcohol. Again, we see some scope for further upward drift here in coming months.

With energy prices remaining elevated and upside risks to the outlook for food and many other prices, it seems that Irish inflation could run somewhat hotter in the next few months. As a result, inflation is likely to be close to 5% per cent for 2022 as a whole.

This would mark the fastest full year outturn since 2007 (+4.9%).More importantly, it will likely be about double the 2021 inflation rate of 2.4% and altogether at odds with the 0.3% annual average increase in Irish consumer prices through the preceding five years. Not surprisingly, the scale and suddenness of this inflation shock has made it a key economic and social concern.

The dramatic increase in living costs in Ireland seen through 2021 largely mirrors similar difficulties worldwide that primarily reflected a sharp turnaround in global oil prices and, to a lesser degree, problems with global supply chains in the wake of the pandemic that led to unusually large increase in a range of goods prices. In themselves, these developments would likely lead to a marked but temporary uplift in a range of prices that would be followed by a return of headline inflation to more normal settings.

Unfortunately, both the scale of price pressures in high profile areas and the fact that they have persisted for nearly a year has led to some spill-overs such as marked increases in fertiliser prices that now threaten an acceleration in food prices.

A more generalised increase in price pressures is now a significant risk for 2022 and beyond but, at this stage, a permanently higher ‘aggravated’ inflation rate remains a risk rather than a reality. With a little luck and considered policy actions, a gradual easing should take Irish inflation materially lower into 2023 but it is likely to run a good deal hotter in coming years than in the pre-pandemic period.    

In common with Governments the world over, Irish policymakers cannot insulate this economy from what is effectively an adverse global supply shock and attempts to do so could well produce even larger and longer lasting economic (and social) difficulties as Ireland’s extremely painful experience of the late 70’s and early 80’s warns.

However, this does not mean that temporary measures are not required to soften the economic blow generally and avoid particularly damaging outcomes for those most affected by the surge in prices. Not to intervene may also increase materially the risk of a damaging wage-price spiral. In these circumstance, it may be economically and socially desirable to implement further targeted interventions in coming months depending on the evolution of energy prices.

The capacity of the Government to undertake some considered and time-bounded supports not only reflects the fact that the Irish public finances have returned to a solidly positive trajectory but also stems from the revenue-enhancing impact of inflation on tax receipts.  

Although the current trajectory of inflation is worrisome economically and socially it is importance not to exaggerate the scale or breadth of pressure on prices at present. In this regard, it may be worth looking at trends through different time frames  as well as isolating the impact of higher global energy prices.

As the diagram below illustrates, the short term momentum in Irish inflation, as illustrated by the 3 month annualised rate (broken blue line), is very different from anything we have seen recently but, at least in part, this is a correction following a strong disinflationary impulse that occurred when the pandemic struck.

In contrast, the light blue dotted line that shows the longer term trend as captured by the two year annualised rate is running at 2% in January 2021. We can further disentangle the extent of particular drivers by considering that excluding energy products, Irish inflation is running at 3.1%% in January and at just 1.7% on a two year annualised basis. 

The balancing act for the Irish Government (in common with others) is to provide adequate economic and social protection to avoid sharp losses for the most vulnerable and a more generalised free-for-all around a destructive wage-price spiral. Finding the right targetted and temporary measures may be necessary but is likely to be far from easy.