Inflation remained subdued in June, rising to 1.8% from 1.7% in May. The slight increase was primarily driven by the biggest monthly rise on record in the cost of package holidays as firms upped prices for the peak summer period. Higher food prices also boosted inflation. Looking ahead, we expect inflation to remain below the European Central Bank’s (ECB) 2% target in the near term, but for it to then move above target in the autumn due to continued strong wage growth, household inflation expectations and a now-neutral deposit rate. 

 

Higher food prices drive goods inflation

The cost of food rose 4.6% y/y in June from 4.0% y/y in May. This helped to add around 5bps to the headline rate and push goods inflation to 0.7% y/y from 0.5% y/y (see chart).

Despite remaining negative, fuel price inflation increased to -4.4% y/y in June from -6.9% in May, which also added 5bps to overall inflation. The Central Statistics Office’s (CSO) collection period broadly coincided with June’s brief spike in oil prices, which was due to the escalation of tensions in the Middle East. However, while some passthrough of prices to the pump can occur immediately, June’s peak didn’t have much impact on inflation because fuel prices fell 0.4% on the month. This makes it the smallest monthly decline since February.

Clothing helped to dampen this month’s slight uptick in goods inflation. Prices remained weak in June, with the annual inflation rate dropping to -2.3% from -1.9% in May. Furniture inflation was also flat at -0.6% y/y.

 

Services inflation stable, but package holidays offset falls

Despite services inflation remaining at 2.4% y/y, package holidays surged by 22.1% m/m, adding 15bps to the headline rate. This rise is the segment’s biggest monthly gain since records began in 2003. What’s more, despite package holiday prices generally behaving erratically, this June’s big rise will likely be followed by further increases in July as the summer holiday season reaches its peak.

Looking beyond package holidays, disinflation elsewhere helped to offset the rise. Hospitality inflation, which has been stubbornly high, continued to ease, dropping to 2.4% in June from 2.8% in May, helping to knock a little over 5bps from the headline rate of inflation.

 

Below-target inflation over summer to rise in autumn

We expect the inflation rate to stay close to the 2% target for the rest of the summer before increasing to around 3% in the autumn. There are a few reasons for this.

First, the Irish economy remains incredibly strong. Wage growth is still well over 5%, which is significantly higher than the 3% level generally thought to be consistent with 2% inflation. Given the strength of the Irish economy, it’s unlikely wage growth will cool enough to return inflation to the 2% target anytime soon.

Second, the Central Bank of Ireland recently highlighted that geopolitical tensions could push energy and food prices higher. These are probably the two components of inflation that influence households’ perception of inflation the most. Food inflation is already at 4.6%. This raises the risk of households bargaining for bigger pay rises to protect their real incomes, which could push up inflation further.

Third, the deposit rate is now 2%, which is broadly in line with our estimate of neutral for the eurozone as a whole. However, Ireland’s economy is far stronger than the rest of the eurozone, suggesting the ECB’s deposit rate could be too low to contain domestic inflation.

 

Tariffs still a downside risk to inflation

Alternatively, an escalation of tariffs could slow global growth further. This would depress demand for Irish exports, with any hit to business and consumer confidence also slowing domestic growth. All else remaining equal, this scenario would mean lower inflation.

There’s also the risk of the US administration’s threat to introduce tariffs of up to 200% on pharmaceuticals. This would pose even bigger downside risks to both growth and inflation, given Ireland’s reliance on the sector.

That said, any retaliation by the EU in the form of higher tariffs on US imports would push inflation up by making them more expensive. It would also put the ECB in a difficult position because trade barriers cause the economy to slow, while rising inflation would mean the ECB struggles to cut interest rates.

Ultimately, we still think the balance of risks is tilted to higher inflation by the autumn. Rising food prices, strong wage growth and interest rates no longer in restrictive territory will all put upwards pressure on inflation. We therefore expect inflation to rise to almost 3% in September’s data.

 

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