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While growth is expected to remain strong and unemployment low, inflation seems set to remain above the euro area average. The increase in consumer prices in 2006, as measured by the HICP (harmonised index of consumer prices), came to 2¾ per cent, with a forecast average HICP rate of 2½ per cent in 2007 . The Central Bank says that rising interest rates and an increased level of housing output has brought a substantial "levelling off" in the rate of house price growth. The bank said although underlying demand factors for housing remained strong, their impact has been tempered by six increases in interest rates since December 2005 together with a high housing output - an estimated 90,000 units completed last year. However, it warned that despite the interest rate rises the demand for credit in Ireland remains strong and that Ireland's private sector credit to GDP ratio was now the highest in the euro zone area. "This is clearly linked to the high volume of housing output in the past few years. Property-related lending has accounted for about four-fifths of the increase in credit over the past year," it said. The Central Bank said that residential mortgage borrowing had pushed personal sector credit to almost one-and-a-half times personal disposable income at end 2006. The bank said that inflation is an increasing risk to the Irish economy’s export competitiveness. The price level in Ireland is currently the highest in the euro area so that any further inflation over and above that of our trading partners would place further pressure on the economy’s competitiveness. Also, a weaker productivity performance in recent years has contributed to relatively significant increases in unit labour costs. There developments have contributed to pressures on the exporting sectors. The Central Bank said that it is important that domestic policies focus on containing inflation, and, in particular, eliminating the inflation differential between Ireland and the euro area. Indeed, it may be necessary over time to have a lower inflation rate in Ireland compared with the rest of the euro area in order for our price level to fall, in relative terms, when compared to our trading partners. The increase in the Consumer Price Index (CPI) during 2006 was 4 per cent, up from 2½ per cent in 2005. The higher rate of CPI inflation was due in large part to the impact of higher mortgage interest repayments, which are excluded from the HICP measure of inflation. Higher interest rates and rising house prices both contributed to the increase in mortgage repayments last year. In other countries, these repayments are generally not included in measures of inflation. The CPI forecast for 2007 is 4½ per cent. The bank said that there are a number of ways in which economic policy can help to limit domestic inflationary pressures. There needs to be more competition in those sectors of the economy where it remains limited. Those engaged in wage setting must ensure that future pay developments protect competitiveness in the light of earlier losses and increased pressures. Boosting productivity growth through longer-term policies such as improving infrastructure, research and development and human capital can also help to improve competitiveness and ease price pressures over time. Fiscal policy also has an important role to play in containing domestic demand. The Central Bank said that the pattern of economic growth has become somewhat unbalanced in recent years with very strong domestic growth alongside, as indicated, a weaker export performance. Consumer spending growth has picked up significantly over the past two years while the level of activity in the construction sector has remained very high. With the substantial increases in housing construction in recent years bringing the level of the housing stock (relative to population) close to that of a number of EU countries, some easing in the level of activity can be expected. A less vigorous growth in domestic demand would contribute to limiting domestic inflationary pressures. This, combined with domestic policy measures, would contribute to a better export performance. Such a rebalancing of demand would contribute to reducing the current account deficit, which has grown to an estimated 3¾ per cent of GNP in 2006. International and euro area economy The Central Bank said that global economic growth accelerated slightly last year, largely reflecting a very strong first half to the year. Global growth has also become more balanced as domestic demand in the euro area and Asia improved, while US growth softened over the course of last year, due mainly to a slowdown in the housing market. The changing pattern of global growth has the potential to contribute towards some unwinding of global economic imbalances. However, the possibility of a disorderly unwinding is a continuing concern. The euro area saw strong growth in the first half of 2006 and, although activity levels moderated in the third quarter, recent evidence suggests a steady continuation of the economic recovery. Encouragingly, euro area recovery has broadened out, with domestic demand contributing more strongly to growth. The outlook for 2007 is good; the euro area economy is expected to continue to grow around potential, although quarterly growth rates may show some volatility. Global headline inflation rates declined over the final months of 2006, reflecting the impact of lowering energy prices. Core inflation rates, which exclude energy prices, have been generally subdued, with moderate wage growth reducing pressures on firms to pass higher costs on to consumers. However, upside risks remain and there are some signs that inflationary pressures could emerge as economic cycles mature. Monetary policies have generally tightened in order to guard against the possible emergence of inflationary pressures, the Central Bank said..
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