Quarterly Bulletin 2023:1 –inflation easing but expected to remain elevated

• Inflation remains high but has begun to ease, with both headline and core inflation now expected to be lower than previously forecast in 2023, at 5 per cent and 3.5 per cent respectively.
• The unemployment rate is expected to remain low, averaging 4.4 per cent out to 2025, with tight labour market conditions continuing.  
• Modified domestic demand is forecast to grow by 3.1 per cent in 2023, 2.9 per cent in 2024 and 2.6 per cent in 2025.

The Central Bank has today (8 March 2023) published its first Quarterly Bulletin of 2023 (PDF 2.82MB). On the launch of the Quarterly Bulletin, Robert Kelly Director of Economics and Statistics said: “The global economic backdrop has performed better than previously expected, and the Irish economy is showing continuing resilience.  As the year progresses, amidst a tight labour market, household real incomes are expected to recover gradually, supporting underlying growth in the domestic economy. The headline inflationary pressures are easing, however inflation is expected to remain elevated in 2023 and 2024, albeit at lower rates than previously forecast.”

He continued “With the economic implications of the Russian war in Ukraine still present, a combination of mild weather and policy actions helped the European economy fare better than expected in recent months.  In Ireland, headline inflation has eased from its most recent peak of 9.4 per cent last autumn, as the effect of the spike in energy prices abates.  Price levels, however, remain significantly higher than before the war and the COVID-19 pandemic.”

Inflation has eased in Ireland in recent months, in part due to measures such as reduced public transport fares and third level education fees. Given the market expectations for wholesale energy prices, and the likely lagged pass-through to consumer prices, headline inflation is expected to be lower than expected previously and continue on a downward trajectory over the forecast horizon.  However, there remains a significant amount of uncertainty around the precise path for inflation, and the extent to which underlying inflation measures such as core inflation will remain elevated.  

Consumer price inflation remains high but is showing signs of slowing.  Annual headline inflation, as measured by the HICP, has fallen from a high of 9.6 cent in July 2022 to 8 per cent in February 2023. Core inflation, which excludes more volatile energy and food prices, has also declined, owing mainly to reductions in public transport prices and third level education fees.  Energy price rises are expected to be a much smaller feature of headline inflation developments in 2023, whereas food and more domestically generated services inflation becomes more prominent.  Futures prices for oil and gas on international markets have fallen markedly since the last Bulletin in October, reflecting a reduction in uncertainty about supplies that had emerged since the onset of the war in Ukraine.  This more positive outlook for energy prices compared to the previous forecast is the main factor underlying the downward revision of HICP inflation forecast for this year of 1.3 percentage points to 5.0 per cent. However, the effect of the energy price shock is still expected to be seen in the price of other goods and services throughout the year, with HICP ex energy inflation of 4.3 per cent expected for 2023, easing to 2.6 per cent in 2025.

Modified Domestic Demand grew by 8.2 per cent in 2022, as consumer spending rebounded from the pandemic and physical investment by MNEs in Ireland rose sharply.  Headwinds from higher inflation have tempered the pace of growth, but these are expected to ease gradually through 2023.  The outlook for real household disposable income, which underpins the forecast for consumer spending growth, has improved relative to the last Bulletin given the lower than previously forecast path for inflation and the continuing strength expected in the labour market.  While real average household disposable income is estimated to have fallen by 0.8 per cent in 2022, it is now forecast to grow by 2.1 per cent and 2.3 per cent in 2023 and 2024, supporting consumption growth of 4.8 per cent and 3.7 per cent this year and next.  Meanwhile, modified investment growth is expected to ease significantly following the exceptionally strong outturn in 2022.  This slowdown is anticipated in both machinery and equipment investment and in building and construction, with the number of new housing units expected to remain below 30,000 both this year and next. Overall Modified Domestic Demand is forecast to grow by 3.1 per cent in 2023, 2.9 per cent in 2024 and 2.5 per cent in 2025.  The positive boost to demand is being tempered somewhat by tighter monetary policy, seeking to bring euro area inflation back to the 2 per cent medium-term target, as well as an assumed normalisation of fiscal policy.

The labour market is forecast to remain tight over the projection horizon. The unemployment rate is expected to remain around 4.3 and 4.4 per cent out to 2025.  Slower employment growth and a pick-up in wage growth through the forecast horizon is expected as capacity constraints become more binding, with compensation per employee expected to rise by 6.4 per cent this year and 5.2 per cent in 2024.  However, the extent of the adjustments still unfolding in the labour market and in the wider economy as a result of the pandemic and the war point to the need to assess carefully recent and near-term developments and whether they may reflect long-term structural change.  For sustainable medium-term growth, with equivalently sustainable rates of underlying inflation, growth in wage rates and profit margins will have to be anchored in underlying productivity growth in the economy.

Irish exports increased by 15 per cent in volume terms in 2022, dominated by the activities of MNEs in ICT services and pharmaceuticals.  Approximately 60 per cent of the growth in the value of Irish goods exports during the year were products shipped out of Ireland.  As in previous years, trade in these fast-growing sectors is expected to provide a continuing boost to economic activity in Ireland over the forecast period. Exports are forecast to grow by 8.2 per cent in 2023, 6.2 per cent in 2024, and 7.9 per cent in 2025. This supports growth in GDP terms averaging over 5 per cent per annum out to 2025.

Domestic policy has a significant role to play in how the economy adjusts to the negative supply-side shock that the war has brought about, with its consequences for national income and the medium-term productive capacity of the economy.  There have been particular challenges since the war came about at a time when there was already considerable adjustments occurring in global and domestic demand and supply conditions arising from the response to the COVID-19 pandemic.  Cost-of-living measures to mitigate the near-term impact of higher inflation have been significant, and in part targeted at those most vulnerable to the costs of the immediate shock. Ensuring these temporary policy measures that support demand conditions are unwound in a timely fashion will reduce the potential of adding to medium-term inflationary pressures and potentially creating a longer-term vulnerability in the public finances.  At the same time, actions that support a transition to a more resilient economy where such shocks are less likely to emerge and be less costly in the future remain crucial.  Using the windfall element of corporation tax receipts to build up the National Reserve Fund is a welcome initiative in this respect. Concerted efforts of domestic economic policy are necessary to sustainably address both immediate challenges such as housing and the green and demographic transitions through appropriate levels and types of investment. This will more readily achieve sustainable growth in the real living standards households and the competitive position of businesses in Ireland over the longer term. 

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