February Inflation Figures - Mazars - Ireland

A snap view and comment on the latest Irish inflation figures from the Central Statistics Office (CSO) and a quick take on official and commercial interest rate prospects.

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Inflation
The latest (February 2011) figures from the CSO show inflation in Ireland running at +2.2% per annum (annual) on the CPI measure and +0.9% on the Harmonised Index of Consumer Prices (HICP). The corresponding price changes for January were +1.7% and +0.2% respectively per annum. The mortgage interest rate component contributed +1.25 % to the overall index CPI February.

On the month to month comparison inflation rose by +0.9% on both indices. On the month there were surges in clothing and footwear for example (+6.5%) reflecting the end of the January sales and in miscellaneous goods and services (+3.8%) following the hike in health insurance.

As to the difference between the two measures: this is accounted for by exclusion/inclusion. Excluded from the HICP are changes in mortgage interest, building materials, concrete blocks, motor and dwelling insurance and motor tax. The HICP is a standardised comparator for EU purposes, particularly ECB interest rate setting while the CPI provides us with a more comprehensive measure of what Irish households are experiencing in their pockets or budgets. Looked at over time the trends since January 2009 have been highly divergent.

Fig. 1 Irish inflation, CPI v HICP (YoY) Jan 2009 – Jan 2011

Source: CSO, 10 February Release

The price level in Ireland in terms of the ‘local shopping basket’ has fallen steeply compared to the EU average. This is not good news. What it shows indirectly is that Irish households are experiencing hurt in their pockets, the effect of the recession and its depth. Some important costs, mortgage service costs, household energy costs, are rising. Also rising are transport and communications costs, all of it squeezing spending power. These are driving the differential between headline CPI and the HICP figure. We are looking at a household sector on the ropes, suffering fiscal austerity, deleveraging and saving hard, fearing more of the same or indeed worse to come. And of course a business sector entirely conscious of domestic debt-depression conditions, eking out demand through holding prices in check. Externally driven cost-push factors (energy, raw materials) in this context are in Ireland demand-depressing, arguably demand-destructive, rather than augmenting inflation expectations or acting as an accelerationist inflationary force. In Ireland we’ve had one spike-and-crash (the bursting of the property/banking bubble). A notching up of EU official interest rates (now certain) and higher global market energy prices could set us up for a double hit and continuing debt-deflation.

The other feature is how weak (negligible) inflation is in Ireland compared with the rest of the eurozone on the HICP-adjusted basis.

Fig. 2 Eurozone annual inflation (HICP), January 2011

Source: Eurostat, 28 February Release

The critical aspect of Fig. 2 in the eurozone setting is not ‘Where’s Ireland'? It is the extent to which so many Member States are hovering around or in some cases well over the 2 per cent figure and the eurozone average HICP has also nudged above that figure, which brings us back to the issue of market and official interest rates.

Interest rates
So where are interest rates going? With official rates at or about the zero bound, in a word ‘up’, and at this point possibly starting in April. Market rates in Ireland are on the move anyway as evidenced in the CPI and the official rate, determined by Frankfurt, will follow (it’s supposed to be the other way round but that’s another story).
So what’s with the ECB? Why pile (or threaten) higher interest rates on pip-squeezed households and the real economy?

Well first, the ECB does not see it like this – and Ireland is not the eurozone. Ireland’s debt deflation is not the ECB narrative. What the Bank sees is an inflation threat around every corner. Further, commercial banking sector liquidity is not its primary concern with again liquidity taking second place to inflation targeting. Its ‘non-standard’ liquidity operations it never saw as anything other than mitigating the adverse effects of temporarily dysfunctional money markets on the liquidity position of solvent banks with always the inflation target (defined as 2 per cent HICP) to the fore.

Alongside the hard inflation targeting is the idea of there being a non-accelerating inflation rate of unemployment or "NAIRU". The legally independent ECB exclusively and simply targets (low) inflation. It is up to others – national governments and the commission – to pursue economic policies that assure high employment and stable growth outcomes consistent with low inflation (NAIRU). Those policies address labour market flexibility, economy-wide competition, ready adoption of technological change and global market conditions – and broadly avoid public spending stimuli. Dedication to and success on these fronts, including fiscal discipline, will ensure that high growth and employment sit comfortably with low inflation rather than the two being, as long considered, alternatives.

The problem is that a one size fits all hawkish monetary policy combined with fiscal discipline, even austerity, sits very uncomfortably with bank insolvency, debt deflation and balance sheet recession. The ECB is not alone in pursuing this policy. The Bank of England is under severe pressure to follow suit as is the US Federal Reserve. Another view exists - HSBC’s chief economist Stephen King recently wrote in the FT, “If interest rates go up and a western recession follows thereafter, central bankers will have been architects to their own monumental failure.”