FASTEN YOUR SEATBELTS and prepare for lift-off.
That’s the message from economists at the moment with more bad news arriving on the cost-of-living front seemingly every day.
First, it was household energy bills. But as ripples from Russia’s war in Ukraine begin to make their way out into the global economy, it’s become clear that from food to construction materials, price inflation is touching everything — and it’s likely to be here for longer than we previously thought.
Outright shortages of goods and inputs are also becoming a distinct possibility as the war takes its toll on fertiliser supplies, metals and grains. Irish farmers are being urged (and monetary incentivised) by the Government to grow more tillage crops amid concern about scarcities.
If all this economic anxiety is enough to drive you to drink, there’s bad news there too. The price of a pint could climb higher due to the loss of Ukrainian and Russian grain to global markets.
As a direct result of higher prices coupled with the impact on international trade, economists now believe that the war and related inflation could weigh heavily on Irish, European and global economic growth this year.
The dreaded ‘r’ word is returning to the political lexicon after a couple of years with Taoiseach Micheál Martin saying recently that a recession can’t be ruled out.
How did we get here and what’s the outlook for the rest of the year?
Acceptable in the ’80s.
Most Irish people born after the 1970s and 1980s have had little or no experience of inflation.
On more than one occasion between 1978 and 1981, the annual rate of price increases topped an eye-watering 20%.
Back then, a series of oil supply shocks throughout the 1970s due to the geopolitical fallout (stop me if this sounds vaguely familiar) from conflicts in the Middle East sent the price of crude and, consequently, petrol and diesel through the roof. Ireland, like most countries at the time, suffered the consequences — higher home heating and car fuel prices.
But more or less, that’s where the similarities between then and now end.
The main culprit in the late 1970s — as former head of macroeconomics at the Economic and Social Research Institute (ESRI) Professor John Fitzgerald, has explained previously — was the relationship between the Irish punt and the British pound sterling.
The value of Ireland’s currency was, at the time, fixed to that of Britain’s on a one-to-one basis. Without going into too much detail, it meant that Irish prices were very sensitive to what was happening in Britain where inflation averaged out at a very high 14% across the whole of the 1970s.
That one-to-one relationship between punt and pound ended in 1978 when Ireland joined the European Exchange Rate Mechanism. Still, inflation hit a bleak 23% in 1981 due to lingering global inflationary pressures, which were magnified by increased government spending at a time when the economy wasn’t in a position to absorb it.
“It’s very different to the context now,” explains Conor O’Toole, Associate Research Professor with the ESRI and co-author of the think-tank’s latest Quarterly Economic Commentary, published this week.
In its latest set of forecasts, the ESRI has upwardly revised its inflation forecasts from 4% to 6.7% this year. That’s well above 2% targeted by the European Central Bank, which is in charge of maintaining price stability across the Eurozone.
“What we have at present is pretty much all being driven by international factors,” O’Toole tells The Journal.
‘Unprecedented increases’
Those international factors were already driving up Irish prices before Russia’s invasion. of Ukraine.
Irish consumer prices were on average 5% higher in January 2022 than a year previous.
Rebounding consumer demand coupled with global supply chain pressures — which made goods and raw materials more difficult to get into the country, inflating their prices — were partly responsible.
But an energy crisis that swept across Europe in the back half of 2021 also conspired to push up the wholesale price of natural gas throughout last year.
All of these factors have now been exacerbated by the war in Ukraine and the various tranches of Western sanctions that have been placed on the Russian economy.
War in Ukraine will push up food and energy prices across Europe
— Agathe Demarais (@AgatheDemarais) March 22, 2022
• Personal savings are not enough to absorb income squeeze, especially in southern Europe (🇵🇹🇪🇸🇮🇹🇬🇷)
• Poorer households to be hit hardest, as they spend higher proportion of income on food/energy pic.twitter.com/yWdwAz4Wnb
“In terms of further sanctions,” the ESRI said this week, “if Western authorities decide, for example, to reduce European consumption of Russian gas, this would almost inevitably lead to higher energy bills over the short to medium-term.”
Alarm bells are being rung across the economy at the moment.
Ireland is “acutely vulnerable” to global energy shocks, the National Competitiveness and Productivity Council warned this week. Being “heavily reliant” on imported gas and oil, the economy is staring down the barrel of more security of supply anxiety and higher home heating and electricity bills as energy markets price in the potential loss of Russian gas supply to Europe in the near future.
Nor is there any relief in sight for Ireland’s motorists.
Global crude oil futures are being buoyed above €116 a barrel and Europe is rapidly running out of diesel as energy companies shun Russian oil.
Speaking at the Oireachtas transport committee this week, David Blevings, a spokesperson for the Irish Petrol Retailers Association, described the crude oil price increases we’ve seen in recent weeks as “unprecedented”.
Appearing at the same committee meeting, AA Ireland chief executive Tom McIlduff said the company estimates an Irish car owner is spending €2,234 on petrol per year or €1,900 on diesel per year. That is €680 more per year than a petrol car driver paid two years ago and €700 more than a diesel vehicle owner was paying.
Food prices are also set to soar.
Ukraine and Russia are two of the world’s largest producers of grains like wheat, barley and corn. Fertiliser prices — a key component of which is natural gas — are also rising parabolically across the continent, heaping pressure on farmers.
Trevor Donnellan, head of economics and surveys at Teagasc, told The Journal‘s The Explainer podcast this week that Irish farmers are already starting to feel the pinch.
He said that because of the “dramatically” increasing cost of grain used to feed farm animals, as well as an increase in the cost of fertiliser and fuel, there would be a knock-on effect for the price of meat and dairy products, as farmers face “substantially” higher costs to produce these commodities.
“That’s beginning to happen already,” he said. “You would have seen, for example, an increase in some food items in the supermarket already and it will continue over the course of the year.”
The ‘r’ word
It’s no surprise then that Irish consumer confidence is taking a bit of a hammering at the moment.
One of the key questions at the moment is whether higher prices will weaken demand within the Irish economy, lessening growth in the process or potentially dragging the economy into a period of recession for the second time in two years.
KBC Bank’s latest consumer sentiment notes a sharp plunge in confidence in March as the war kicked into full gear followed by round after round of western sanctions on the Russian economy. The ten-point drop in the bank’s confidence index represents the 11th largest monthly decline in the survey’s history.
That’s no shock, KBC Bank’s Chief Economist Austin Hughes said, given the “torrent of bad news on living costs” in recent weeks. “Consumers were notably more pessimistic in relation to the prospects for their household finances in the year ahead,” Hughes added, “with negative responses outnumbering positives by over 4 to 1 in March compared to just under 2 to 1 in February”.
The combined impact of higher prices and greater uncertainty in global trade is likely to weaken growth this year compared to previous forecasts, the ESRI said this week.
Although Irish GDP is still expected to grow robustly by 7% in 2022, this represents a downgrade from the ESRI’s last set of projections before last Christmas, when it had pencilled in growth of 6.2% this year.
Modified Domestic Demand — a measure of domestic economic activity that strips out the distorting impact of multinationals and the aircraft leasing sector — is also forecast to grow by 5%, down sharply from a previous forecast of 7.1%.
Investment and trade are also expected to grow but at a weaker rate than expected as businesses make difficult choices against the backdrop of rising prices.
However, the outlook is still relatively positively, the ESRI’s O’Toole said.
“I think if inflation follows the line in terms of our forecasts and if the labour market follows that as well, it’s likely we will still get household consumption growth this year,” he said.
“But there’s huge headwinds really on the economy, and the risks are on the downside,” he added.
“And that can’t really be understated at this stage.”
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