Mr. Brendan O'Connor:

I thank the committee for the opportunity to appear before it. My colleagues Mr. Cullen and Mr. Sheridan are from our income tax and indirect tax units, respectively.

We are meeting at a time of unprecedented uncertainty and economic volatility. As well as the ongoing humanitarian crisis, Russia's invasion of Ukraine has created a large supply side shock that has shaken the global economy, with European economies at the epicentre. Given Russia's outsized role in global energy supply, oil and gas prices have risen sharply in recent months. As Ireland is a global price taker, this has fed through to higher energy prices for businesses and households.

It is important we give some context to the current inflationary environment. The emergence of inflationary pressures contrasts markedly with the relatively low inflation we experienced for the guts of the past decade. In Ireland, inflation averaged at 0.5% between 2010 and 2019 and at 1.5% in the euro area. Initially, the Covid-19 pandemic exacerbated this low inflation environment. As the decline in demand in 2020 outstripped the fall in supply, Ireland's inflation turned negative, reaching something like -0.5%.

While consumer price inflation remained subdued in Ireland in the first quarter of last year, the annual rate of inflation picked up sharply thereafter, with both domestic and global factors behind the increase. These included a recovery in energy prices from their lows in 2020 - we call these base effects - as well as global supply chain disruptions, supply side bottlenecks and pent-up demand. To address this, budget 2022 in October contained an income tax package to the value of €520 million. This involved increases in the standard rate band and key personal tax credits. On the expenditure side, a social welfare package worth approximately €560 million was introduced, as were a range of other measures, including health and childcare supports, aimed at mitigating the cost of living. At the time of budget 2022, inflationary pressures were expected to ease over the course of the winter and throughout this year. However, higher than anticipated energy prices throughout last winter resulted in higher than expected inflation in the winter and into early spring.

The war in Ukraine has served to exacerbate inflationary pressures further. Inflation stood at 7.25% in April, which was the highest rate since the harmonised index of consumer prices, HICP, series began in 1997. This is a trend we are seeing in all advanced economies. In the euro area, inflation reached 7.5% in April. Today, the US reported that its inflation rate had reduced to 8.3% in April from 8.5% in March. The rates in the UK have been similar.

Higher energy and commodity prices are expected to continue feeding into higher inflation over the coming months. As set out in the stability programme update, SPU, in late April and based on market prices at the time of the forecast, inflation is expected to remain elevated in the near term, peaking in the second quarter of this year and averaging at approximately 6.25% for the year as a whole. Pass-through price effects are also expected in other sectors such as food through higher prices for energy and fertilisers - the latter is a by-product of higher energy prices itself - and consumer goods and services, also through higher energy prices and transport costs, with core inflation of approximately 4% projected for the year. A significant easing is anticipated next year, with the headline rate projected to be approximately 3% for 2023 as a whole. In fact, energy prices, while still expected to stay high, are expected to ease next year.

Higher energy and commodity prices will erode the real incomes of households while also denting the margins of firms. This, alongside heightened uncertainty, will dampen consumer spending and private sector investment this year. In this manner, inflation will act as a headwind against output growth. As a result, we have revised downwards our forecast for modified domestic demand growth – our main indicator of economic activity – by approximately two and a quarter percentage points this year, with growth of 4.25% being forecast.

These projections were produced against a backdrop of exceptional uncertainty. As such, risks to the forecast are considerable and firmly tilted to the down side. In light of this, we also published a scenario analysis in the SPU in which wholesale oil and gas prices returned to their early March levels – indeed, slightly higher – and remained elevated relative to the baseline throughout this year. Gas prices in this scenario are 75% above the baseline projection and oil prices are approximately 50% higher. In this scenario, inflation would be two percentage points higher this year at 8.25% – peaking at 9.25% in the third quarter – and one and a quarter percentage points higher next year at 4.25%. Of course, the energy price shock would not only affect inflation and would also have broader macroeconomic implications. Output in the domestic economy would be approximately 2% lower over the medium term and the budget surplus of in or around €1.2 billion for next year would be wiped out.

I will outline the Government's more recent response to increases in energy prices from a taxation perspective, and my colleagues from the Department of Public Expenditure and Reform will speak about expenditure measures. In early March, the Government approved a VAT-inclusive reduction in excise duty of 20 cent per litre on petrol, 15 cent per litre on diesel and 2 cent per litre on marked gas oil, MGO, amounting to €320 million. Further measures were announced in mid-April, including a reduction in the VAT rate for electricity and gas to 9% from 1 May until the end of October, which should result in estimated annual savings of €49 on gas bills and €69 on electricity bills for households. The cost of this measure is estimated at €46 million. There was also a further VAT-inclusive reduction of 3 cent per litre on MGO from 1 May and an extension of the reduction in excise duties on MGO, auto diesel and petrol to mid-October, with a combined cost just shy of €100 million.

Overall, including the expenditure measures that colleagues from the Department of Public Expenditure and Reform will shortly outline, cost-of-living measures announced since the budget amount to just over €1 billion on top of the roughly €1.1 billion in measures announced in budget 2022.