Finance Minister Paschal Donohoe also warned generous tax cuts could backfire
The Government must resist public-sector pay demands as much as possible if it wants to keep a lid on inflation, the Economic and Social Research Institute (ESRI) has said.
Finance Minister Paschal Donohoe will also have to rein in expectations of tax cuts or lavish cost-of-living spending in Budget 2023 to avoid generating further upward price pressure, the influential policy think-tank added.
In its latest quarterly economic commentary, the ESRI said any pay increases must be “carefully considered”, while reducing the taxation burden would “constitute an unwarranted stimulus”.
“From a national point of view and from a macro-economic point of view, the objective of government policy at the present time has got to be to not additionally fuel inflation,” ESRI economist Kieran McQuinn said.
“We’ve talked about this growing risk of domestically generated inflationary pressures because of the tightness of our labour market and because of how strongly we’re growing.
“The Government is going to have to demonstrate as much discipline as it can.”
Prices on average were 7.8pc higher in May compared with May 2021 – the highest rate of inflation since 1984.
Pay talks last week stalled as unions said no to a 5pc pay deal.
But some of the country’s highest-paid public servants’ wages will rise by more than €20,000 next week, when cuts imposed during the financial crisis are reversed.
Senior hospital consultants’ pay will jump by 10pc, or €22,972, to €252,150 a year, while the salary of the Chief Justice will increase by 8.9pc from €271,648 to €295,916 – a pay hike of €24,268.
Official figures reveal that secretaries-general of government departments will also receive pay rises of 8.9pc.
The ESRI warning is likely to bolster the Government’s reluctance to loosen the purse strings further as consumers deal with the steepest annual price rises in 40 years.
Inflation hit almost 8pc last month due mostly to a spike in energy prices following Russia’s invasion of Ukraine and lingering post-pandemic supply-chain disruptions.
In the past month, Mr Donohoe has repeatedly warned there is limited fiscal capacity to soften the blow from the increase in the cost of living.
He and his officials have instead emphasised the need to reduce the deficit and pay down debt, despite balancing the books last month, after two years of heavy spending on State Covid supports.
While the ESRI is forecasting a general government surplus of €1.6bn by the end of the year, the growth outlook is softening.
Mr McQuinn and his ESRI colleague and report co-author Conor O’Toole see risks on the downside.
“We are seeing some head winds affecting domestic demand, in particular the persistent increases in inflation,” Mr O’Toole said.
“This is likely to negatively affect the consumption channel in particular, but also the broader outlook, with uncertainty due to the war in Ukraine likely to be affecting the investment outlook.
“And we’re also moving towards a period where central banks are becoming increasingly aggressive.”
He said coming rate rises from the European Central Bank would hit consumer spending, business investment and house prices, cooling off a hot Irish economy.
Despite the warnings, the ESRI is still expecting growth in modified domestic demand – considered the most accurate reflection of Irish economic growth – to hit 4.4pc this year, down from 6.5pc growth in 2021.
GDP (Gross Domestic Product) growth for this year is forecast to be 6.8pc, reflecting the strength of the multi-
national sector, especially IT and pharmaceuticals.
The ESRI is also forecasting “full employment”, with the jobless rate coming down to only 4pc by the end of next year.
Nonetheless, consumer confidence has taken a battering, falling 18pc since the beginning of the year to be the lowest level in the European Union.
The ESRI further noted a “persistent decline” in indications of household savings as the money put aside during the pandemic was now “getting eaten up in price increases”, Mr O’Toole said.
It is a far cry from the ESRI’s forecast last summer, when it said Irish consumers would be spending freely in 2022 as the “going-out economy” rebounded after Covid lockdowns.
The fact that inflation was running higher than real income growth meant people were likely to feel poorer, notwithstanding the very strong growth dynamics in the country.
“GDP masks the real situation on the ground,” Mr McQuinn said.
“The risks are definitely on the downside.”
However, there might be some wiggle room at budget time for the Finance Minister after all.
The ESRI believes the €3.5bn contingency fund set aside this year is unlikely to be spent, leaving spare spending to spread around.
“There is still some fiscal space to assist those most affected by higher costs of living,” the report said.
“However, this will have to be done in a targeted manner.”