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Ireland’s inflation held steady at 2.7% in February. However, today’s release will feel somewhat irrelevant for households and businesses across Ireland. The recent surge in oil prices due to the conflict in Iran will start feeding through to fuel-pump prices and home heating oil almost immediately. For now, this will prevent any further reduction in headline inflation beyond what we’ve seen in recent months.
Ireland’s inflation set to rise strongly
February’s inflation figures already feel out of date given events in the Middle East and their wider impact. Live data suggests the cost of heating oils has already started rising sharply and pump prices are nudging up. Indeed, motor fuels inflation dropping to -3.1% in February from -2.3% in January will be of no comfort to firms and households now preparing for another bout of higher inflation.
That said, February’s inflation data did show a second consecutive rise in services inflation, taking it to 3.7% from January’s 3.6%. That lends further evidence to our view that domestically generated inflationary pressures would persist this year.
Either way, inflation has slowed in the last few months. However, the recent rise in energy prices means inflation will rise strongly over the next year.
Ireland’s inflation outlook flipped will rise this year
Rising oil prices will have an immediate impact on the Irish economy. We estimate this will add a little over 0.5ppts to inflation between now and April’s CPI release. In fact, weekly data from Eurostat suggests that the cost of heating oil has rocketed 60% since the end of February, which would suggest an upside risk to this estimate.
Rising natural gas prices will also feed through to household energy bills, but with a longer lag. The peak impact on inflation is unlikely to show up until the second half of this year. Combined with the rise in oil prices, inflation will probably increase to around 3.5% by the end of the year.
However, this forecast relies on current energy futures curves, which suggest that the markets expect a relatively swift resolution to the conflict. Evidence of prolonged disruption could see them move sharply higher, further raising the inflation outlook. We think inflation reaching 5% isn’t off the cards. In any case, inflation is now set to rise, rather than ease, over the course of this year.
Will the ECB raise interest rates?
This situation is similar across Europe and the eurozone. This makes the outlook for the European Central Bank (ECB), which we had expected to keep its rates on hold this year, more complicated. The ECB will want to ‘look through’ a negative supply shock to focus on the downside impact on demand given inflation will likely only be elevated for a year.
However, ECB President Christine Lagarde recently asserted that the ECB would ensure that “Europeans don’t suffer the same inflation increases like those we saw in 2022 and 2023”, while other members of the Governing Council have begun to talk up rate hikes. Despite medium-term inflation expectations remaining well-anchored, the Governing Council is aware that households will be hyper-attentive to inflation given the impact of the war in Ukraine is still fresh in mind.
Ultimately, we think the ECB will wait to see for now how the conflict plays out. But, if it continues over the coming months, significantly pushing up inflation across Europe, then a rate hike seems likely.
