Oliver Mangan: No relief in sight from high energy costs

The role of higher energy costs remains critical in terms of the surge in inflation, writes Oliver Mangan.

Wholesale gas prices remain elevated. File image.

The drop in the Irish inflation rate to 5% in January from 5.5% in December will prove short-lived.

It is largely down to a base effect as there was little of the usual winter sales in January last year, owing to the economy being in lockdown.

Indeed, it is unlikely that we have seen the peak in Irish inflation yet, with oil prices surging again over the winter.

They have risen by one-third since early December. Meanwhile, wholesale gas prices remain elevated.

The role of higher energy costs remains critical in terms of the surge in inflation. The Irish CPI rate, excluding energy prices, is 3.1%. In the eurozone as a whole, where the inflation rate is running at 5.1%, the ex-energy rate is at 2.6%. Even then, the impact of higher energy costs is also evident in the core rate, such as the very sharp rise in airline fares.

There would seem to be little short-term relief in store in terms of energy prices.

Oil and gas inventories are at very low levels. The demand for oil and gas picked up strongly with the sharp rebound in economic activity over the past year. However, producers have not increased output accordingly, resulting in a marked fall in oil and gas stocks, which led to the sharp rise in oil and gas prices.

Without a sizeable increase in production, it is difficult to see energy prices falling back anytime soon.

Opec is holding the line on oil output and is reluctant to increase production to any great extent. Geopolitical tensions in Eastern Europe are adding to the problem, but the fundamental issue is that the market is undersupplied and available stocks are depleted. These need to be rebuilt over the northern hemisphere summer to avoid a further rise in energy costs.

Labour markets are very tight also, with the unemployment rate at circa 4% in the US and UK, and 7% in the eurozone, a record low. Persistent high energy prices are likely to fuel wage demands in tight labour markets. It can also lead to second-round effects where higher energy costs for manufacturers and service providers get passed on to consumers.

There is already evidence of this happening in the US, where wage growth is running at 5% and the core CPI rate has picked up to 6%.

Central banks may be slow off the mark, but will respond eventually, if they fear inflationary pressures are becoming embedded in their economies.

Tighter monetary policy will slow economic growth and thus the demand for energy. Recent analysis by the Bank of England showed the damage that a sustained rise in energy prices, combined with a tighter monetary and fiscal policy stance, could do to the UK economy.

Efforts by oil and gas producers to maintain tight supplies and thus high prices, could eventually backfire.