David NcNamara: Ireland exposed to oil shock but has buffers to soften the blow
Tanaiste and Finance Minister Simon Harris at Government Buildings. While Ireland is exposed to energy price shocks, the continued surge in corporation taxes means the Government has a war chest to dampen the effects. Picture: Brian Lawless/PA
As outlined in this column last week, the current conflict in the Middle East raises the risk of a fresh inflationary shock to the global and Irish economies, which if sustained could lead to a downturn later this year.
In 2022, post the invasion of Ukraine, the economy faced a simultaneous energy price and confidence shock. While this did significant damage at the time, in general, a European recession was avoided outside of the highly exposed German economy. Up until now, the ramp up in energy prices is less than was seen in 2022, particularly for gas prices which remain a fraction of the 2022 peak. However, Brent Crude has broken through the key $100/barrel in the week since the attacks on Iran, compared to a peak of $130 reached following the invasion of Ukraine.
The question remains how the Irish economy would fare if it does face a sustained shock like that seen in 2022? In terms of our energy mix, we have made slow progress on reducing our reliance on imported oil and gas. The latest SEAI āEnergy in Irelandā report showed 81% of our energy came from fossil fuels in 2024, albeit energy emissions were down nearly 12% compared to 2021, ahead of the Ukraine war, and 32% lower versus the 2005 peak. Steady progress in decarbonisation should lessen the blow of a fresh energy shock, but the economy remains highly exposed to global market prices.Ā
Globally, the IMF has stated that a 10% increase in oil prices, ā if persistent through most of the year, would result in a 40-basis-point increase in global inflation. Oil prices are now up 40-50% on the pre-Iran invasion level.
In terms of the magnitude of a potential inflationary shock, Irish CPI inflation reached a peak of 9.3% in October 2022, which at present is unlikely to be replicated given natural gas prices have not yet surged to the same extent as then. However, inflation could rise sharply in the coming months if this oil shock is sustained.Ā
Based on current market conditions and direct pass through to consumers could see annual CPI inflation rise to around 4% from the current 2.7%. This does not account for second-round effects seen on other prices such as food, transport, and general services, as was experienced during 2022, so the peak could be higher still.
However, while Ireland is exposed to energy price shocks, we have also built-up significant resilience to weather them. In 2022, the Government used its enviable budget surpluses to rapidly expand subsidies to households and other sectors to dampen the effects of rising energy prices. Today, domestic indicators suggest the economy is growing at around a 3% to 4% pace. In particular, the continued surge in corporation taxes means the Government has an even larger war chest than four years ago, if it chooses to use it. In the private sector, household and business balance sheets are also in a healthy position with debt levels low and substantial savings built up.
So, a short-term sticking plaster of fiscal supports is possible if this energy shock endures, but a longer-term strategy will be required to further lessen the impact of global market volatility and build up national energy resilience to future shocks.
