Economic Letter: Fall in value of Sterling directly increases spending power of Irish consumers

An Economic Letter by Paul Reddan and Jonathan Rice examines the role of exchange rates on recent consumer prices in Ireland. Given Ireland’s exposure to British trade, it stresses the importance of considering bilateral exchange rates, namely EUR:GBP, when considering the impact of currency volatility on Irish inflation. This is particularly relevant given the volatility in Sterling in the aftermath of the Brexit vote. The key findings are:

• Currency exchange rates influence the price of traded goods, which pass through to both producer and consumer prices. This is particularly important for Ireland, a small open economy with a large share of trade outside the euro area.
• Sterling has a disproportionately large impact on Irish consumer goods prices, above and beyond other currencies, given the UK’s role as a key trade partner for consumer goods. A large quantity of goods imported from the U.S (particularly pharmaceuticals and aircraft) are not consumed in Ireland, while 50 per cent of total manufacturing goods and 78 per cent of food, beverages and tobacco imported from outside the euro area come from the UK.
• The Brexit-related fall in the value of Sterling helps explain why Irish inflation remained lower than all other euro area countries throughout 2016. The falling cost of British exports meant Irish consumer goods prices have been particularly low and this has directly increased the real purchasing power of Irish consumers.
• The model used in the Economic Letter suggests that the sudden and persistent depreciation in the value of Sterling immediately following the UK-EU referendum led to consumer prices being approximately 1.2 per cent lower over the course of a year than would have been the case had Sterling remained stable. In light of unfolding Brexit negotiations and a potential Bank of England interest rate rise, Sterling volatility in future will have important consequences for Irish prices. A sharp rise (fall) in the value of Sterling of just 1 per cent could in turn see Irish prices increase (decrease) by 0.15 per cent over the course of a year.

The views presented in Economic Letters are those of the authors alone and do not necessarily represent the official views of the Central Bank of Ireland.

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