The Impact of Oil Prices on Irish Inflation

Oil prices have been characterised by large fluctuations in recent years. Strong volatility in oil prices has important implications for the Irish economy as Ireland has a relatively poor fuel endowment and relies heavily on imported oil. Energy price increases have been one of the principal drivers behind HICP inflation rates in Ireland in recent years. This article highlights the distinctive features of the Irish energy market which render the impact of oil price changes on Irish inflation different to the average impact felt at the euro area level. The direct effects on inflation are stronger in Ireland than in the euro area, reflecting the higher dependence on both oil and gas. The pass-through of higher oil prices to petrol and diesel prices at the pumps is slower than the euro area average but there is no evidence of pricing asymmetries. Indirect effects appear to be of a similar order of magnitude to the euro area average. Given the Irish economy’s relatively high wage flexibility, and in particular the low incidence of automatic wage indexation, it is likely that second-round effects in Ireland are more contained than in the euro area. Irish pre-tax diesel and petrol prices are roughly comparable to euro area levels reflective of improved competition, whereas heating fuel is considerably more expensive. Pre-tax electricity and gas prices remain significantly above the euro area average and further steps are needed on the path to full liberalisation of the retail electricity and gas markets. Measures to reduce oil and gas dependency by, for example, greater recourse to renewable energy resources, will help mitigate the impact that oil price fluctuations have on Irish inflation.