Friday 9 December 2016

Inflation now set to return for first time in 18 months

Economy may face period of ‘stagflation’ if prices keep rising

NICK WEBB and HARRY LEECH

Published 15/08/2010 | 09:27

TIPPING POINT: ECB is buying Irish bonds in policy reversal
TIPPING POINT: ECB is buying Irish bonds in policy reversal

INFLATION is set to return to Ireland after a near 18-month absence, according to forecasts. However, the economy could face a period of damaging "stagflation" if prices rise too far.

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Stagflation occurs when an economy experiences anaemic growth while also suffering from inflation or rising prices.

It was last experienced by Ireland in the grim 1970s, according to economists.

Stagflation causes major problems for economies as it it is difficult to reverse. Boosting spending to kick-start the economy causes inflation to rise, while hiking interest rates to dampen inflation impacts on economic growth.

Last week, CSO figures showed that prices had fallen at a negligible rate, with analysts predicting that inflation could return for the first time for 18 months.

“Next month’s Consumer Price Index reading is almost certainly going to show the first positive inflation reading since December 2008,” according to Ulster Bank economist Simon Barry. Davy Stockbrokers has predicted that inflation will return in the early autumn.

Coupled with a stagnant economy, which may experience a 0.7 per cent drop in GDP this year, according to PwC, Ireland may be looking at an era of stagflation.

This may be exacerbated by stubbornly high unemployment rates, which may hit 13.5 per cent at the end of this year before slipping slightly next year. Although the Central Bank recently forecast growth rates of about 2.2 per cent next year, other estimates are considerably lower.

Moves by AIB and Bank of Ireland to hike mortgage rate prices and plans by the ESB to yank up customer prices are seen as key drivers in pushing the economy back into inflation territory.

Education costs have risen 9.2 per cent this year, with insurance costs rising 10 per cent already this year. Sharp falls in the euro’s value against sterling have also meant that food, drink and clothing costs may shoot upwards, as many of these products are imported from Britain. Rising oil prices are also set to play an increasing influence in coming months.

It is not clear how high inflation will reach, with estimates for inflation rates in 2011 ranging up to 2.1 per cent.

However, some economists believe that the Irish economy may avoid the shackles of stagflation, with Dolmen’s Oliver Gilvarry forecasting that inflation rates will range between 1.0 per cent and 1.25 per cent in 2011. He sees inflation as a positive step, as rising prices and wages will help to erode debt.

Fears over the health of the fragile economic recovery mounted last week, as the cost of Irish government debt soared to its highest levels in months. Central Bank governor Patrick Honohan said the rates demanded by markets for Irish bonds were “ridiculous” and “a setback to our hopes of a narrowing to reflect the fiscal credibility of our country”. Late last week it was reported that the European Central Bank had moved to buy Irish bonds in a drastic reversal of its financial policy.

The increased cost of the Anglo Irish Bank bailout was coupled with concerns that savage government spending cuts would overwhelm any recovery.

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