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Inflation eased a little in May, thanks to weaker fuel inflation, and will probably ease a little more in June as more favourable base effects drag on services inflation, and lower oil prices mean that fuel inflation will slow a little more. Further ahead, we expect inflation to pick back up as rate hikes increase mortgage interest inflation and utility bills start to be hiked. Fuel excise duty could also push up inflation materially if the government let emergency measures expire.
Inflation eased slightly in May
Inflation eased from 3.7% to 3.6% in May.
This was primarily driven by easing oil prices and the government’s measure to cut fuel excise duty as motor fuel inflation fell from 16.9% to 14.6% and heating oil inflation slowed from 80.4% to 60.1% and lopped 24bps off headline inflation.
However, this was offset by a rebound in services inflation from 3.2% to 4.0%, due to surging airfares which jumped from -18.4% to 14.1% after the impact of the early Easter faded. Airfares will probably continue to trend up throughout this year as the impact of higher jet fuel prices raise input costs for firms. Mortgage interest inflation also pushed up the headline measure as mortgage rates have jumped since the outbreak of the war in Iran on the expectation of future ECB rate hikes.
Food inflation also slowed to 1.3% from 2.0% but will surely rebound later this year as higher fertiliser and diesel prices make their way through supply chains.
In the immediate term, we expect headline inflation to continue to ease in June as more favourable base effects help to weigh on services inflation and fuel prices continue to nudge down, helping inflation to dip below 3.5%.
Rebound in August, unless government extend fuel cuts
Further ahead, we think inflation will jump back up in August for a few reasons. First, and most importantly, the governments emergency cuts to fuel excise duty are due to expire on 31 July, which could add around 0.6ppts to headline inflation once this fully flows through to retail prices. In any case, we think the risks are skewed towards the government extending these measures for a little longer given previous fuel protests and the government’s healthy budget surplus which would see inflation peak lower.
Second, the impact of higher natural gas prices, which take longer to feed through to consumers than oil prices, will start to show up in the inflation data from next month. For example, Electric Ireland, the country’s largest electricity provider, has already announced it will raise electricity and gas bills by 8% and 7.7% respectively in July.
Third, the ECB hiked rates today, and will probably raise them once more later this year, which will push up mortgage interest inflation further as banks pass that hike onto mortgage holders. Indeed, mortgage inflation has already jumped up from 5.2% in February, before the crisis, to 7.7% as the expectation of ECB rate hikes pushes up mortgage rates.
All told, we now see CPI inflation averaging 3.5% this year as the combination of higher energy prices, fertiliser prices and a resilient domestic economy all contribute to above target inflation which will drag on real household incomes and hence growth this year. Admittedly, this is lower than our previous forecast of 3.6% as weekly data from the European Commission suggests that home heating oil prices are falling back quicker than we initially anticipated.
In any case, elevated inflation will eat into real household incomes this year, which will drag on consumption. The good news is that households are saving over 10% of their incomes which should allow them to offset some of the hit on their incomes through lower savings. In any case, we see Modified Domestic Demand (MDD) growing by around 2.5-3.0% this year, down from last year’s 4.9%.
