Inflation forecast to largely cancel out pay rises as energy price hikes 'erode' disposable income

In its latest quarterly bulletin, the Central Bank is projecting that inflation is expected to hit 3.5% throughout this year before falling to 2.9% next year, and 2% in 2028.

The recent surge in inflation is expected to eat into wage increases through the rest of this year as higher energy prices continue to “erode” real household disposable incomes leading to a more “subdued” consumption growth, the Central Bank of Ireland said.

In its latest quarterly bulletin, the Central Bank is projecting that inflation, driven by the spike in energy prices resulting from the conflict in the Middle East, is expected to hit 3.5% throughout this year before falling to 2.9% next year, and 2% in 2028.

In the bulletin, the Central Bank said “expectations around real wages have declined”, with “nominal wage growth not expected to keep pace with inflation in the near term”.

“Personal consumption growth is expected to be more subdued as higher energy prices continue to erode real household disposable incomes.” 

The bulletin projected that despite the uncertainty, compensation per employee in nominal terms will increase by 4% this year and 4.1% next year. Growth is then projected to slow to 3.7% in 2028 as labour market conditions ease and unemployment rises modestly.

That means real wage growth this year is expected to increase by only 0.5% this year.

“Real gross disposable income per household is forecast to decline by 1% in real terms in 2026 due to elevated inflation and increase by an annual average of 0.7% in 2027 and 2028, respectively,” the bulletin said.

Director of economics and statistics at the Central Bank, Robert Kelly, said during the previous energy shock there was an increase in workforce participation leading to more two income households.

However, because there is a weaker labour market, at the household level Mr Kelly said they expect some contraction when it comes to real gross disposable income per household.

The bulletin added that the continued slowdown in job postings alongside redundancy announcements in the higher-paying tech sector may exert downward pressure on nominal wage growth this year. Unemployment is expected to remain around just over 5% over the coming years.

On the energy crisis front, Mr Kelly said “even when the conflict is fully resolved the restoration of supply chains will take an extended period”.

“For Ireland, higher energy costs are eroding household real incomes and damping consumer confidence, while also feeding through to broader inflationary pressures. The longer the conflict lasts, the more embedded the impact becomes in higher prices across the economy.”

In terms of the wider domestic economy, the Central Bank expects modified domestic demand (MDD) to grow by 3.3% this year and 2.8% next year.

The bank noted that a large part of the increase in MDD is coming from AI-related activities such as data centres and other products for export.

Head of Irish economic analysis at the Central Bank of Ireland, Martin O’Brien, said “we have seen over the last two years, and last year in particular, a big uptick in MNE AI-related investment” adding "13% of total imports now are these sort of AI-related bundles of products that go into the data centres or go into other products for export”.

Mr O’Brien added that because the data centres are a physical investment in the state, this investment is also reflected in modified domestic demand.

Public finances

The Central Bank also published a signed article that assessed the medium-term outlook for the public finances. 

It found that, excluding windfall corporation tax, budget balances are forecast to deteriorate out to 2030, with a lower proportion of estimated windfall corporation tax being saved.

“Continued spending overruns would further deplete fiscal buffers, with the underlying deficit deteriorating to 6% of GNI, or €25.7bn, by 2030, adding to inflationary pressures and limiting the government’s capacity to respond to future negative shocks,” the bank said.

It added that the tax base needs to be broadened to cope with future spending requirements as well as mitigate the risk from a potential loss of corporation tax.