Jim Power: Confused picture for Central Bankers 

The ECB's Governing Council is due to meet early next month to discuss interest rates cuts with the threat of trade war looming. 

In the world of economics and politics the surge in inflation in 2022 and the subsequent tightening of interest rates to bring it back under control has really been the biggest economic and political story in many countries around the world over the past couple of years.

As 2024 progressed it seemed that the battle against inflation had been won as headline inflation rates decelerated sharply and central banks responded with a so far quite significant easing of interest rate policy.

However, the legacy impact on the cost of living following a period of rapid price increases has had a significant impact on politics, not least in the US, where the Biden administration got hammered despite what looked on the surface like a very strong economy. The cost-of-living crisis is still a real thing in many countries.

Data on prices in many jurisdictions over the past three months is now giving central bankers cause for some concern.

In the US the headline inflation rate hit 3% in January, up from a low of 2.4% in September; UK inflation also hit 3% In January, up from a low of 1.7% in September; and eurozone inflation hit 2.5%, which is the highest rate since July of last year and up from a low of 1.7% in September. What all of this means for interest rates in 2025 is now an interesting and not straightforward question.

From the perspective of the ECB, it seemed very clear in January that aggressive interest rate easing would characterise the year ahead, but the doyens of monetary policy in Frankfurt must have cause for some concern and confusion based on recent indicators.

At one level the eurozone economic background is still extremely weak, but there are price pressures building in the system.

On Friday last, the Purchasing Managers’ Index for manufacturing suggested contraction in that sector for the 23rd month in a row, and service sector activity is barely growing. Yet, the index is showing that business input costs are at their highest level since April 2023, and output prices are at their highest level in 10 months. The story in the US and UK is quite similar in relation to inflationary pressures.

One of the problems is that most countries are still enjoying very low levels of unemployment and wage pressures are feeding into service sector inflation in particular.

It is also the case that food and energy prices, which are notoriously volatile, have also been rising in recent months. To confuse the picture even further, if Trump delivers on his tariffs and the EU responds in kind, this will feed into higher import prices in both jurisdictions and consequently into headline inflation.

My sense is that for the ECB in particular, the economic background is characterised by stagnation, and while tariffs might have a temporary impact on imported inflation, they would ultimately have a negative impact on already very weak growth.

This suggests to me that the ECB should continue to cut interest rates, with the next cut justified in March. However, there is a difference between should and will, so nothing is certain, but the weak economy argument must ultimately win out.

In Ireland, headline inflation hit 1.9% in January, up from a low of 0.7% in October. Here also, the biggest problem is on the services side. Service sector inflation was running at 3% in January and goods inflation at just 0.3%.

Increased labour costs are feeding into inflation as demonstrated by the costs of eating out for example.

For the Irish consumer the bottom line is that although the headline rate of inflation has fallen sharply from the highs of 2022, the average cost of living in January 2025 was 19.8% higher than in January 2020.

The strained consumer is the reality for consumer-facing businesses, but for those businesses, the environment is made even more challenging by State-induced measures, particularly labour market measures.