Quarterly Bulletin 2022:4 - Energy-driven inflation causing uncertainty and challenges for domestic growth

• Stronger than anticipated growth in the first half of 2022 expected to give way to much lower growth in coming quarters, with forecast for modified domestic demand (MDD) revised down for next year. MDD is forecast to grow by 6.4% in 2022, 2.3% in 2023, and 3.3% in 2024.
• Consumer price inflation forecasts have been revised up to 8.0% in 2022 and 6.3% in 2023, reflecting sharp increases in future price of gas on wholesale markets since previous Bulletin in July, with price growth moving below 3.0% during 2024.
• Tight labour market conditions are expected to continue in the main, supporting wage growth and a re-emergence of real income growth for households next year.

The Central Bank has today (5 October 2022) published its final Quarterly Bulletin of 2022. On the launch of the Quarterly Bulletin, Robert Kelly, Acting Director of Economics and Statistics said:

“Energy-driven inflation is the key issue we are currently facing and as a result the outlook for domestic growth over the coming quarters is more challenging than was previously expected. The labour market is performing well since the post-pandemic recovery, however significantly higher consumer prices and business costs are expected to impact both household spending and business investment in the short-term. As inflationary pressure starts to ease through 2023, domestic growth is expected to pick up again in the second half of next year, while inflation is expected to move below 3.0% over 2024.”

He continued “With the supply-side already experiencing constraints during the transition out of the pandemic, the economic implication of the Russian invasion of Ukraine is one of a large supply-side shock to the Irish and European economies. As the disruption to energy, food and commodities markets has materialised, the knock-on, upward effects on consumer prices and consequent reduction in domestic purchasing power has become more substantial through 2022.”

The economic effects of the war in Ukraine, primarily rising energy prices and uncertainty about energy supplies, are ultimately leading to lower consumption and investment than would otherwise be the case. A large increase in investment in the first half of 2022, likely more once-off in nature, means that the forecast for modified domestic demand (MDD) for the full year 2022 is revised up. However, underlying this the expected growth during the second half of the year is revised down. The drag of higher inflation on disposable incomes is expected to maintain through to the first half of 2023, but ease thereafter. Average real household incomes are forecast to fall by 3.3% this year, and to remain relatively flat next year as a whole. This expectation, coupled with more precautionary savings, means that consumer spending is projected to grow at a slower pace than previously predicted, particularly in 2023. MDD is forecast to grow by 6.4% in 2022, 2.3% in 2023, and 3.3% in 2024.

Consumer price inflation forecasts have been revised up to 8.0% in 2022 and 6.3% in 2023. These revisions reflect sharp increases on the assumptions for the future price of gas. Natural gas accounts for about half of electricity generated in Ireland, and increases in the price of gas, pass through to the retail price of electricity as well as gas for home heating. Higher electricity prices impact the wider economy as firms’ production costs also increase. Consequently, the expectation is that the pass-through of energy to other parts of the consumer basket will continue for some time, with inflation excluding energy expected to average 4.4 per cent in 2023, revised up from 3.8% forecast in the July Bulletin.

Export growth has, and is expected to continue to be strong, driven by the pharmaceuticals and ICT services sectors, even in the presence of a more subdued international growth outlook. However, the exports of indigenous firms, particularly those reliant on the UK market, may be more challenged by the subdued international growth outlook and recent currency movements. Exports are forecast to grow by 14.2% in 2022, 8.2% in 2023, and 6.2% in 2024, and therefore are expected to continue contributing to strong recorded GDP growth.

Tax revenue has grown strongly in the first nine months of the year. The general government balance (GGB) is now forecast to move from a deficit of €7bn in 2021 to a surplus of €1.5bn this year (or -3.0% to +0.6% of GNI*). This improvement reflects the positive impact of economic recovery on revenue growth and a surge in corporation tax receipts, with the surplus expected to grow further over the forecast horizon reaching €9.8bn (3.2% of GNI*) in 2024. Excluding windfall corporation tax receipts, the current forecast would show a GGB deficit of €7.5bn in 2022, with a modest surplus of €0.8bn (0.3% of GNI*) emerging in 2024 on this basis, highlighting the sensitivity of the public finances to developments in this tax category. The general government debt ratio is projected to record a large decline in the coming years, but to remain at an elevated level of 74.5% of GNI* in 2024.

There remains upside risks to the inflation forecast and downside risk to the growth forecast. Much of the slowdown in growth forecast in the second half of this year and early next year is contingent on currently high energy prices stabilising, alongside a smooth transition to more sustainable energy supply. However, a more intense and protracted war in Ukraine or a further deterioration in energy or food supplies would result in lower growth and higher inflation than outlined in the baseline forecast. A less favourable growth path for the UK would have slightly negative implications for the growth forecast, while a larger appreciation of the euro vis-à-vis sterling would imply weaker inflation than currently forecast.

The economy’s adjustment to the energy-focussed supply-side shock will be shaped by policy choices and the ability of businesses and households to manage higher costs. Fiscal and monetary policy measures can play a role in minimising the extent of the cost of this shock over the medium term, distributing it across the economy and society, and supporting the necessary transition to a more resilient position where such shocks are less likely to emerge and be less costly in the future. In addressing the immediate challenges, policy should continue to be mindful of longer-term objectives and seek to align near-term supports and incentives with achieving longer-term objectives and broad economic resilience given the challenges of climate change, population ageing and housing.

Further Information

 This Quarterly Bulletin also contains a Signed Article by Simone Arrigoni, Laura Boyd and Tara McIndoe-Calder titled “Household economic resilience”.

The research uses the results from the Household Finance and Consumption Survey to estimate the effect of higher inflation across households based on their consumption patterns and levels of financial buffers. The authors find that while many households remain resilient, fragilities exist. Increases in food and energy prices alongside rising rents have a much greater impact on household finances than interest rate increases on variable rate mortgages. This reflects the smaller share of mortgage interest in household expenditure relative to food and energy, among other factors. In a ‘severe’ scenario involving further price increases for essentials, the analysis shows that households in a more precarious financial position with limited savings buffers (around 15 per cent of all households) would see 44 per cent of their disposable income used for spending on just this limited set of essential items. Targeted, temporary supports for more exposed households will support consumption of essential goods and services until price rises abate and/or real incomes rise.

Previous Quarterly Bulletins are available to view on the Central Bank’s website.