The sharp drop in the value of the pound looks set to trigger price rises of up to 10 per cent across a range of items, with clothing, footwear and many basic groceries expected to become more expensive in the months ahead. Most economic forecasters had signalled that inflation would rise in 1998, with the most pessimistic pointing to an average increase of around 2.5 per cent, peaking at around 3 per cent in August, but slipping back again towards the end of the year. The events of the last few days, however, have largely put paid to this view, sending most analysts back to make some upward revisions. In the absence of any clear signal from the authorities as to whether the pound will join monetary union at its current central rate in the ERM band of DM2.41, it now seems certain that any revised forecasts will put average inflation at 3 per cent or more for this year.
This week the Central Bank admitted that inflationary pressures had so far been shown to be well below its expectations. The Bank, together with most economists, had expected to see some evidence of rising inflation some months ago, in response to the prolonged weakness of the pound against sterling.
The Irish currency has been trading at relatively weak levels against sterling for most of 1997, making it more expensive to import items such as clothing and grocery products from Britain. But, despite this, higher prices have not yet been passed on to consumers.
Virtually all of the major importers will have locked into currency rates for anything from six months to a year and would, therefore, have been unaffected by any change in the value of the Irish currency over that period. However, there were signs that most of these contracts were coming to an end as early as last August. Since then, aggressive competition in the thriving Irish retail sector, it seems, has managed to keep a lid on prices, with retailers choosing to absorb the higher import costs rather than put up their prices. This was based on the view that the pound's weakness against sterling was merely temporary.
This time last year, the pound was trading at parity with sterling, having previously traded as high as 106p. Most of the prices of imports in the supermarkets and shops would most likely have been based on an exchange rate at or close to parity with sterling.
At current rates, the pound is down by 15 per cent against the British currency and the possibility of further falls cannot be ruled out. At these levels, it is expected that retailers will now be keen to push prices up to maintain their profit margins.
However, the almost inevitable pick-up in inflation in the coming months is expected to be a onceoff adjustment. Moreover, while it will heighten concerns about the wider implications for the economy, few economists believe it will kick-start a spiral of wage and price inflation.
On top of these price increases, further inflationary pressures are expected to accelerate in the second half of 1998, as Budget tax cuts and lower interest rates put more money in people's pockets. But the most serious threat would be if inflation were to rise sufficiently to scupper the Partnership 2000 wage agreement. The trade unions, which have already voiced their dissatisfaction with aspects of the Budget, will closely watch the trend in inflation to gauge whether the wage increases agreed under Partnership 2000 are in line with the rate of inflation. Annual average inflation rates of between 2.5 per cent and 3 per cent would still be broadly in line, but the pressures would mount if inflation were to spiral beyond these levels. While there is broad agreement that inflation is on the way up, factors such as the high level of competition in the Irish retail and other sectors will help to contain the size of any price increases. The weakness of south-east Asian currencies will also help to keep inflation down, as many of the major importers will be sourcing products from these regions at very favourable rates.
