WHAT A DIFFERENCE a few weeks makes. Coming into the year, there was doom and gloom about economic prospects for 2023. But, the mood music seems to be changing.
Economic growth is holding up. Inflation continues to trend lower. Job markets remain strong. Energy armageddon was avoided. China’s economy is re-opening after ditching its zero-Covid policy. Forecasters like the IMF and EU Commission are beginning to revise up their predictions for growth this year. And, Ireland is still in a far better position than many European countries.
Somewhat unexpectedly, the European economy didn’t shrink in the last three months of 2022. The EU stalled while the 20-member Eurozone registered a minuscule 0.1% advance. As several economists have already pointed out, however, if the distortions caused by Ireland’s multinational sector were stripped out of our own 3.5% quarterly growth rate, that may have been enough to see the entire European economy as a whole contract.
Europe has weathered the Winter energy storm better than many had feared. Wholesale gas prices have fallen back from the stratospheric levels they reached in the months following Russia’s invasion of Ukraine. There are several reasons for this: 1) concerted efforts to conserve energy, 2) full gas storage facilities, 3) diversification of supply, and, in particular, 4) a warm Winter. However, as people are realising when they receive their energy bills this month, falling wholesale prices have not yet been reflected in retail prices.
Assuming there isn’t another energy price shock in the coming months, the annual inflation rate should continue to slow through mid-Summer.
Wholesale gas prices are not only lower than they were before Russia invaded Ukraine, but they are also back to mid-2021 levels, though still more than double previous levels. If they stay roughly where they are, or even decline further, this should feed through to lower bills. On top of the universal €200 electricity credits, the last of which will be paid next month, there will be further relief of €12.73 per month to bills through September due to the recently confirmed Public Service Obligation (PSO) rebate.
If lower wholesale energy prices are not passed on to customers, then government needs to take steps to stamp out price gouging. In fact, there is an argument for concerted efforts to increase competition and tackle profiteering across the economy given Ireland has the most profitable businesses in Europe, double the EU average. There is no wage-price spiral. We need to make sure there is no profit-price spiral.
The ECB eased off the economic accelerator from last Summer, increasing interest rates from below zero towards what economists call the “neutral” interest rate. In reality, the neutral rate is unknowable, but it is believed to be around 2% in the Eurozone. But, they’ve kept increasing interest rates and have signalled that more are on the way. This is like jumping on the brakes. The European economy is at a standstill, and we haven’t even seen the full effect yet of those recent rate hikes. Perversely, when we hear “good news” on the economy, the ECB hears “bad news”, and looks to tighten the screw further.
The answer to rising rates is not the reintroduction of mortgage interest tax relief. As others have argued, that’s a terrible idea: regressive, expensive and poorly-targeted. Non-zero rates are not a temporary phenomenon, they are the new normal. Ireland already treats property exceptionally favourably in terms of tax and subsidies compared to peer countries.
We should not be repeating the mistakes of the past. Housing policy needs to focus on increasing supply, not subsidising demand.
The extension of some of the temporary cost-of-living measures introduced last year before they expire at the end of February comes as no surprise. It was obvious at the time of the budget last September that more would need to be done and that there was enough money in the public coffers to do so.
So, the €1.3bn cost-of-living package announced by the government this week will be a welcome drop in the ocean. An extra €200 on welfare and €100 on child welfare is not anything. It will ease the pinch on low-income households and those with children. But, these “one off” measures just postpone the moment of reckoning.
If wages and welfare rates are not permanently increased in line with inflation, then lower living standards are locked in.
Phasing out the reduced VAT rates on hospitality and fuels will add to inflation, but the arguments for extending them are not nearly as strong as they were for introducing them in the first place. Prices at the pump have fallen back by a quarter since peaking at over €2 per litre last Summer. In fact, they are lower than at any time since the Autumn of 2021. The Temporary Business Energy Support Scheme (TBESS) was already more generous than supports to households when it was introduced on budget day back in September. Now it is being made more generous just as household supports are tapering off.
The economic mood music may be improving, and government cost-of-living measures should help at the margin, but further ECB rate hikes and the grinding downwards of real household incomes suggest we are not yet past the worst.
Victor Duggan is an economist.
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