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In welcome news for consumers and businesses, oil prices helped the Consumer Prices Index (CPI) rate of inflation fall in May to 1.7% from 2.2%. However, the decline was otherwise mostly due to base effects and the big rise in May last year falling out of the annual comparison and weakening services inflation. All of this takes inflation below the Central Bank of Ireland (CBI) and European Central Bank (ECB)’s 2% target. Looking ahead, our assessment sees the risks tilted to inflation accelerating to around 3%, but any escalation of US tariffs on the EU would slow both growth and inflation.
Services inflation eases
May’s headline inflation rate reduction was driven primarily by a base effect. Looking at monthly change in prices, which can be a better indication of current inflationary pressures, prices were unchanged between April and May.
What’s more, services inflation eased markedly to 2.4% from 3.6%. Weakening hospitality inflation knocked 10bps off the headline rate, but it was still the biggest driver of inflation. Notably, it’s also the first time hospitality inflation has dropped below 3% since February 2022.
This fall in services inflation was compounded by erratic components, such as airfares (-12.5% from +16.6%) and package holidays (-3.6% from +10.1%), unwinding. The effect of a late Easter in April dampened May’s headline figure, removing around 60bps from the headline measure.
Goods inflation – while subdued – boosts headline number
It was goods inflation that put most upward pressure on the measure in May, rising to 0.5% from 0.1% thanks to food inflation increasing to 4% from 3.4%. However, goods inflation overall remains weak. Falling clothing prices and cheaper fuel thanks to the recent drop in oil prices mean goods inflation remained subdued.
Inflation close to 3% by September
Despite a drop in the headline figure to 1.7%, we still think inflation will be closer to 3% than 2% by September. There are a few reasons for this.
First, the ECB has continued to cut interest rates to boost a flagging eurozone economy. Given the relative strength of Ireland’s economy, we think this runs the risk of overheating and price inflation. The ECB has at least one more cut in the current easing cycle, so this pressure is unlikely to fade anytime soon.
Second, wage growth is still over 5%, which is far too high to return inflation to 2%. Indeed, the ECB believes 3% wage growth is roughly consistent with 2% inflation. With a tight labour market, it looks unlikely that wage growth in Ireland will materially cool enough to return inflation to 2% any time soon.
Tariffs should dampen inflation
While we seem to have avoided the worst-case scenario on tariffs for now, another surge in uncertainty, combined with any direct effects, will materially slow growth. This would help create a margin of slack in the economy and put downward pressure on inflation. US President Donald Trump also recently threatened 50% tariffs on the EU, which would further exacerbate that slowdown further.
Ireland would be by far the most affected EU economy from further US tariffs. Fortunately, the ECB would likely step in to support the rest of the eurozone with further cuts. However, given the scale of Ireland’s exposure, additional interest rate cuts would probably do little to cushion the blow.
Exports of medical and pharmaceutical products made up 45% of Ireland’s goods exports in 2024, so pharmaceuticals will be a key area of focus for tariffs. In Q1, firms were front-running tariffs in anticipation of April, which boosted GDP for this period by 9.7%. If pharmaceuticals and medical products come into Trump’s view on tariffs, then this could cause a material slowdown in growth.
The other big risk is that the EU retaliates in kind to US tariffs and raises the cost of imports to the bloc. Retaliatory tariffs would put the Irish economy in a difficult position because trade barriers cause economies to materially slow and the ECB would struggle to cut interest rates to support growth thanks to rising inflation.
Overall, we think the risks still tip towards higher inflation over the summer despite broader factors, such as an appreciating euro, weighing on inflation. Domestic factors, such as strong wage growth and further interest rates cuts when rates are already too low for the Irish economy, will put upward pressure on inflation. We expect inflation to be close to 3% by September.
