Is Brexit keeping a lid on Irish inflation?

Consumer prices

New research from the Central Bank of Ireland suggests that Brexit had a dampening effect on Irish inflation and increased the spending power of Irish consumers in 2016.

In an economic letter titled “Exchange Rate Pass-Through to Domestic Prices”, Central Bank economists Paul Reddan and Jonathan Rice looked at the impact of foreign exchange rates on consumer prices in Ireland.

The research shows that the low rate of Irish inflation in 2016 was largely due to the weakness in the value of sterling, which fell sharply against the euro in the wake of the UK’s vote to leave the EU.

Ireland’s low inflation rate contrasted with inflation in the euro area which began to increase through 2016.

The research noted that weakness in sterling lowers the price of Irish imports from the UK, leading Irish retailers to pass on this reduced cost by lowering prices for these goods.

The fall in sterling can also have the effect of lowering the price of domestically manufactured goods which depend on imported inputs from the UK.

“Disproportionate impact”

 According to the report, fluctuations in the euro-sterling exchange rate have a disproportionate impact on Irish inflation compared to other currencies.

This is due to the volume of Irish imports from the UK and the fact these imports largely consist of manufactured goods and food-related products.

“This finding aids our understanding of the significant impact that sterling weakness has had on recent Irish consumer goods inflation,” wrote the report’s authors.

“It also explains why Irish inflation remained lower than all other euro area countries throughout 2016,” they added.

The Central Bank economists said upcoming Brexit negotiations made it “imperative” to understand the impact of the value of sterling on Irish inflation “as forthcoming negotiations surrounding British exit from the EU are likely to have major consequences for the euro-sterling exchange rate”.

See also: Exchange Rate Pass-Through to Domestic Prices