Central Bank warns excess government spending could increase inflation 'significantly'

The Central Bank has warned the Government against breaking its own expenditure rules, predicting such spending could impact inflation.

The warning came as the Central Bank hiked its 2023 core inflation forecast to 4.9 per cent, up from 3.5 per cent three months ago, adding that it expects the measure to peak later this year.

While inflation, as measured by the Harmonised Index of Consumer Prices (HICP), has almost halved in the last year to 5.4 per cent, core inflation hit 5.7 per cent in May, surpassing the headline rate for the first time since prices began to rise sharply.

The Central Bank also increased its forecast for the HICP this year to 5.3 per cent from 5 per cent and sees the headline rate falling to 2.5 per cent in 2025, when core inflation, which excludes unprocessed food and energy prices, would still be running higher at 2.7 per cent.

The bank said uncertainty relating to its forecasts had diminished over the last three months and the risks to its inflation projections are marginally to the upside.

However, with the economy growing strongly and also at full capacity due to a record low unemployment rate of 3.8 per cent, the trajectory of core inflation hinges on firms' ability to absorb wage increases the bank sees averaging 6.2 per cent this year and 5.9% in 2024, without unduly increasing prices.

The Central Bank said the Government risked "significantly" adding to inflation in the coming years if it breaks its own expenditure rule and increases government spending by more than 5 per cent year-on-year.

Ministers budgeted for an increase in spending of more than 6 per cent this year to fund measures intended to ease the burden of higher inflation on consumers and have indicated they may breach the spending rule again in October's budget for 2024.

The Government has also said on top of this it intends to increase the level of capital spending for the rest of the decade. -Reuters