Prices still falling as Ireland slowly closes gap with euro area

CPI and HICP both down 0.2% in October

• The CPI and the HICP (the standard measure across the euro area) both fell 0.2% in October. That brings the decline since peak in the CPI to -6.7% and the HICP to -3.4%.

• Both indices would have dropped by that much again was it not for the huge hike in third level education registration fees that added 0.2 percentage points.

• Ten of the 12 categories in the price basket fell month-on-month. Communications was unchanged, and education was the only part of the index to rise.

Ireland becoming more competitive: prices rising in the euro area but falling here

• We expect the CPI and HICP to head in different directions from here. The CPI will probably be marginally higher by end-2010 as mortgage rates are hiked (banks pushing up margins and ECB increases in H2 2010). The HICP, which has no mortgage component, is likely to slip another 1% from here.

• That contrasts with the euro area where prices (as per the HICP) are rising again, making Ireland more competitive. Ireland has closed the price level gap by 3.4% with the euro area so far, but there’s more to go.

• Many international clients have asked us if this deflation is pernicious. We don't believe so. Note that the best measure of domestically-generated prices is services ex-mortgages. Prices in this part of the index spiralled in 2000-mid-2008 (+52%), but they are not falling rapidly and are down only 0.8% from peak. In any case, retailers entered this recession with fat margins. Some of this excess is being shed, while underpinning real incomes.

HICP to decline both intra-year and on average in 2010

• We forecast a 0.3% decline (i.e. full year average in 2010 versus 2009) for the CPI next year (there is a negative carryover but it will rise intra-year), whereas the HICP may fall 1.3% on average in 2010.

Goodbody economist Deirdre Ryan commented:

Deflation extends to -6.6% yoy in October...- Irish deflationary trends continued unabated last month with the annual pace of decline in the CPI extending to a new record rate of -6.6% (-6.5% in September). Price declines continue to outpace those seen in the rest of Europe as seen in the HICP indicator. In the year to October the HICP declined 2.8% (-3% in September), compared to a -0.1% decline for the Euroarea as a whole over the same period. However, the decline in Euroarea inflation is largely energy related. Excluding energy from the HICP shows the Euroarea HICP rose 0.9% in the year to September compared to a -2% decline on this measure for Ireland over the same period.

...although monthly decline could have been doubled - October’s monthly decline was the smallest seen in the year so far although this was largely due to the fact that education prices rose sharply last month (from 4% yoy to 11% yoy), owing to an increase in college registration fees. Had this not occurred the monthly decline in the CPI would have been doubled.

Relative prices adjustment continuing at pace - Clearly the adjustment in Ireland’s price levels relative to elsewhere is continuing at pace. The CPI index is now at levels last seen in Q1 2007 and at this stage of the year it seems likely that the CPI decline for the full year will average in the region of -4.4%. While the pace of decline is set to moderate as we enter 2010, we still expect a further annual decline of c.1% next year. Combined with the adjustments taking place in relation to property prices and rental levels (residential rents are down 23% form the peak), along with wage developments also where wages continue to adjust downwards, its clear that Ireland is making clear progress

Simon Barry, chief economist, Ulster Bank commented:

October consumer price data show that the aggregate price level fell by a further 0.2% last month. This was a weaker outcome than had been expected and resulted in an intensification of deflation pressures as measured by the Consumer Price Index. The annual rate of change in prices now stands at -6.6%, down from -6.5% in September. This marks a new low for the cycle and represents the most intense bout of deflation the economy has experienced since the second quarter of 1933.

The breakdown reveals that there was significant upward pressure from prices in the education area. The increases in third-level registration fees from €900 to €1500 resulted in a 10.8% monthly increase in education (and culture) costs, in the process adding over 0.2% points to the monthly change in the October CPI. However, this was a major outlier compared to the general pattern of price movements.

Outside of education, 10 of the remaining 11 categories of prices within the CPI all showed declining prices on the month (communications prices were unchanged). Notably, transport prices were down 1%m/m reflecting a 2% drop in petrol prices and a 0.9% fall in car prices. There was also a 1% decline in furnishings and household equipment prices and a 0.9% fall in clothing and footwear, with ongoing discounting among retailers continuing to exert downward pressure in these areas. Elsewhere, food price declines were again very evident; the 0.5% fall in October was the ninth consecutive monthly decline.

The 0.2% monthly fall in the October CPI compared with a 0.2% decline in the same month in 2008, but rounding effects produced the deceleration in the annual rate to the -6.6% as noted above. This huge decline continues to be dominated by the effect of the significant reductions in ECB interest rates over the past year, the effect of which accounts for 4.2% points of the 6.6% decline in the total CPI. However, the depressing effect of past ECB rate reductions is set to wane sharply, beginning next month.

…but base effects from mortgage and energy costs means this is the low point of the inflation cycle… The ECB’s rate cutting cycle commenced in October last year, and began to feed through to the inflation figures from November. Mortgage interest payments fell by about 8%m/m in both November and December last year, the base effects from which will exert significant upward pressure on the annual comparisons in the months ahead. Similarly, large declines in energy costs late last year (as crude prices plunged in the wholesale markets) are another source of unfavourable base effects for the CPI into year end.

The above two factors look set to boost the annual rate of change in the CPI by about 2.5% points by the end of the year. There will probably be some offset from continued weakness in underlying price pressures. Indeed, it is very much the case that measures of core consumer prices continue to trend lower. Core inflation in both the goods and services areas made fresh lows in October (see graph), consistent with the weakness in pricing power brought about by the weakness in the economy generally. But overall, the -6.6% reading for last month will represent the low point for this cycle, and CPI inflation will probably end the year in the ball park of -4%.

…albeit that underlying price pressures continue to weaken, helping to improve Ireland’s price competitiveness: Indeed, deflation has already begun to ease back a touch on the HICP (European harmonised) measure. This measure (which excludes mortgage interest payments) went from -3% y/y in September to -2.8% last month. Despite this modest acceleration, Irish HICP inflation remains considerably below that of our main trading partners. The latest rate from the UK stands at +1.1% and the euro zone at -0.3%, so Ireland continues to make important progress in improving her international price competitiveness.

Overall, downward pressure on the Irish price level remains strong. While base effects in mortgage and energy costs will result in less negative inflation readings in the months ahead, the latest trends confirm that underlying price pressures continue to weaken. Lower prices clearly reflect the weak state of the economy, but the large-scale price declines seen of late do boost purchasing power and thus provide some buffer against the cuts in social welfare spending which look increasingly likely in next month’s Budget.

Price falls must be reflected in income expectations – IBEC

IBEC senior economist Fergal O’Brien said: "It is vital that these price falls fully translate into cost reductions for businesses, so that Ireland can regain its competitive edge. Prices are now falling for all goods and services, with the exception of education, and this must be reflected in nominal income expectations for next year.

"Price falls are likely to continue for some months yet. However, the fact that global commodity prices have already rebounded and exchange rates are unlikely to have such a downward influence on domestic prices next year, means that the pace of deflation in 2010 will be nothing like what we have seen this year.

"The annual change in the monthly CPI will most likely return to positive territory around the middle of next year, but the CPI will remain marginally negative for next year as a whole," concluded O'Brien.

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