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Thomas Molloy: Unpalatable choices must be made to curb inflation

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THE return of inflation to 30-month highs here in Ireland is part of a much bigger story that has sent prices soaring in most poor and rich countries over the past few months.

Inflation is one of the factors behind the riots that have brought down dictators across North Africa and triggered food riots in India and elsewhere.

In the West, inflation is reducing spending power at a time when wage costs are falling or only rising slowly. The Bank of England warned earlier this week that inflation in our nearest neighbour will soon hit 5pc while salaries are expected to increase by just 2pc.

Countries such as China are raising interest rates by a quarter point every two months to try and choke off inflation and prevent political unrest, which is bubbling dangerously beneath the surface in the world's most populous nation.

South Korea is battling to reduce inflation running at 6.3pc, while closer to home, Norway hiked interest rates yesterday to keep inflation there under check.

Even Germany, where policymakers have a morbid fear of inflation, is now contending with a 2.7pc rate.

Against this backdrop, most analysts here were fairly sanguine about yesterday's figures from the Central Statistics Office which showed that prices rose 3.2pc in the 12 months to April and 0.4pc in just one month.

The analysts noted that around a third of this increase can be attributed to rising energy prices, which have jumped 12.5pc in the past year and around 40pc of the hike is due to the rise in mortgage costs following the ECB's recent decision to raise interest rates for the first time in three years.

The EU Harmonised Index of Consumer Prices, which excludes mortgages rates, rose a more modest 1.5pc or almost half the 2.8pc average in the rest of the eurozone.

Using this measure, Irish inflation is currently the lowest in Europe and less than half the rate seen in the other bailout nations that are still suffering from the twin evils of shrinking growth and soaring prices.

Still, many of the other European economies have been enjoying stellar growth, while we still don't really know if or when the recession ended. Inflation here comes at a time when most private and public sector workers are already contending with falling wages. In other European countries prices are rising far slower than wages, which are being pushed higher by labour shortages.

There are many grounds to hope that our inflation rate will start to fall soon.

Oil prices are heading downwards and this should bring down the price of almost everything from vegetables to train fares.

The Government's announcement this week that it will cut VAT for some products and services will also have an effect, although it remains to be seen how much of the VAT cuts will actually be passed on to consumers. Previous experience here and elsewhere suggests it may be less than some expect.

It is not just local commentators who believe inflation will soon start to fall. The International Monetary Fund yesterday pencilled in inflation of just 0.5pc this year and next year, but there are still reasons to be concerned.

Sheltered from competition, the public sector is still pushing up prices at a time when many businesses are flat on their back. Health costs rose 4.1pc in the last year. Utilities and local charges rose 3.5pc.

Compare this with the restaurant and hotel sector, where prices have fallen 0.9pc despite rising commodity prices that pushed up food and drink prices by 1.4pc.

The Economic and Social Research Institute said earlier this week that inflation figures may not be capturing the real picture anymore because the basket of goods used by the CSO may be out of date.

One important example is tracker mortgages, which were not popular when the base indices were created. Their popularity now means the statistics agency may be exaggerating the effects of interest rates increases. The ESRI's Joe Durkan also speculated that consumers may be avoiding some of the worst inflation by radical shifts in shopping patterns. People may be paying fewer visits to GPs and hospitals for example.

While this may allow consumers to avoid overcharging, there are obvious social consequences.

At first sight, it may seem that the Government cannot be blamed for inflation that has been triggered by higher interest rates and higher energy costs, but there are some actions that could be taken to reduce imported inflation.

The Government could force home buyers to take out the sort of fixed rate mortgages common elsewhere in Europe. This would mean that home owners were immune to interest rate hikes and would reduce the effects of interest rate hikes on our inflation rate.

The Government could also reduce our reliance on imported energy by promoting wind energy. These are long-term projects, but the truth is that this country is too dependent on imported oil and gas and we have far more variable mortgage rates than almost anywhere in the western world.

The seemingly insatiable desire for commodities from the world's emerging economies as well as worrying signs of political instability in countries as diverse as China and Saudi Arabia suggest that large swings in household basics such as heating fuel and bread suggest that inflation may well rise and fall at dizzying rates in the years ahead -- making planning for families and governments even more difficult than it is now.

Where Irish inflation is heading in the short term remains to be seen. Most of the smart money suggests that we will see a steady dip towards the end of the year but further hikes to interest rates by the ECB to stem inflation elsewhere in the eurozone, political unrest in the Middle East and higher costs for many imported goods sold in our discount supermarkets could also conspire to keep inflation at uncomfortably high levels for sometime to come.

Irish Independent