Those arguing that the current upsurge in inflation would be temporary – a finite manifestation of the post-Covid unwind – were already on the back foot before Russia's invasion of Ukraine threw global energy markets into disarray.
The argument has now been put to bed. We’re in the midst of an oil and gas price shock akin to those that rocked the world economy in the 1970s.
Whether the price surge and the likely monetary policy response will result in stagflation – a period of high inflation and low growth – as it did in the 1970s remains to be seen.
Headline Irish inflation – put at 5.6 per cent in February, the highest level recorded since 2001 – masks the full extent of the squeeze on households.
Electricity and gas prices are up 22.4 and 27.8 per cent respectively year on year, while home heating oil is up by 54 per cent. A worrying aspect to these numbers is that they don’t reflect the jump in wholesale energy prices being paid by energy retailers here, meaning an even more painful pass-through to consumers is on the way.
A marker of where we're headed was provided by SSE Airtricity in the North last week, which announced a 39 per cent increase in gas prices. Industry insiders say 20-30 per cent price increases for electricity and gas are likely to be announced by providers in the Republic in the coming weeks.
The pressure on low-income households, which are forced to use a greater share of disposable income on necessities, is likely to be intense.
Powerless
Opposition parties can berate the Government for not doing enough but it is powerless to arrest the trend and unable financially to do much to compensate the average household.
While the cut in excise duties on diesel and petrol announced this week has reduced price of a 60-litre tank of petrol by €12 and the cost of a tank of diesel by €9 at a cost of €320 million to the exchequer, that’s merely reversing the price increase of the past two weeks.
As KBC Bank Ireland economist Austin Hughes notes, the effect of the measures will be to "restrain rather than reverse the current upward momentum".
While regulators and think tanks have yet to update their forecasts for inflation in light of Russia’s attack on Ukraine, it’s safe to assume we’ll move above 6 per cent in coming months with the forecast risk heavily skewed to the upside.
The Ukraine crisis has intensified upward pressure on global oil and gas prices. And the second round effects are likely to float out into the marketplace in the near term as businesses try to insulate themselves from larger and longer-lasting cost pressures. It was these second round effects that regulators including the European Central Bank (ECB) were convinced we would avoid provided the price hike was merely linked to post-Covid supply chain issues but that ship has sailed.
ECB tone
The tone and action of ECB pronouncements has altered accordingly. While announcing an end to asset purchases or stimulus in the third quarter, possibly paving the way for an interest rate hike later this year, ECB chief Christine Lagarde said: " The Russia-Ukraine war will have a material impact on economic activity and inflation through higher energy and commodity prices, the disruption of international commerce and weaker confidence", while calling the conflict a "watershed for Europe".
The bank is caught between two objectives: if it take steps to combat higher consumer prices by raising interest rates it could wind up hurting growth and stalling the tentative recovery from Covid, while continuing to support growth with low interest rates will fan further inflation.
While the outlook for economic growth remains broadly positive, the euro zone is more exposed to the war and is more dependent on Russian oil and gas than the US and China and therefore more vulnerable economically.
A sequence of inflation–combatting interest rate hikes – heaping mortgage repayment pressures on already struggling households – combined with a prolonged energy price shock, increases the risk of stagflation, something we haven’t experienced since the 1970s.
