The world’s central banks, slow to react to the re-emergence of inflation during the post-COVID-19 recovery, have been making up for lost time.

Last week, there were further increases in official interest rates in the US, in Britain and in the eurozone.

These are the rates at which central banks borrow from, and lend to, the commercial banking system and higher official rates feed quickly into retail rates for businesses and households.

In due course, they affect rates on corporate and Government bonds, so the holiday from heavy debt service costs has come to an end.

There were clear signals in last week’s announcements, notably from the European Central Bank, the one that matters most for Ireland, that monetary tightening is not over yet and interest rates could rise further in the months ahead.

Official interest rates at the ECB have now risen to 2.5%, at the Bank of England to 3.5% and at the US Federal Reserve to a range of 4.5% to 4.75%. All had been close to zero, or even slightly negative, for several years.

The ECB has been slowest to raise rates and its president, Christine Lagarde, was the most hawkish last week about the next steps.

All the main central banks have an inflation target of 2% and no government has abandoned that target. The central banks have decided that higher interest rates must now be endured, as well as an end to their purchases of government debt, printing money at one remove.

Tight money is the medicine when inflation threatens but the fear is that tightening too much, or too quickly, could worsen the economic slowdown already under way.

The central banks will not wish to share the blame with Vladimir Putin but understand that loose monetary policy helped to jolt inflation upwards before the invasion of Ukraine.

The most recent rate hike in the US was just a quarter of a percent, versus half a point in the eurozone and in the UK.

Half-point increase

Remarks by the Fed chair, Jerome Powell, have been interpreted as signalling that one more small rate hike in America might be enough, while the ECB has kept its options open.

There will probably be another half-point increase for the eurozone in March and then it is wait-and-see. If the economic slowdown in Europe gathers pace and inflation begins to subside, the ECB could relent.

There is scant evidence of an economic slowdown in Ireland, at least not yet, and the Irish economy has outperformed its eurozone partners since the emergence from the financial crash.

With a common currency, hence a common monetary policy, higher interest rates might even be seen as the appropriate policy stance, since the macro economy may be overheating and out of sync with the rest of the eurozone.

Evidence includes the tight labour market, buoyant tax revenues and the persistent pressures on house prices and rents. In her remarks last week, the ECB president cautioned against governments pursuing any loosening of budget policy, which would conflict with the tightening stance of the central bank.

The outstanding Exchequer debt stood at €226bn at the end of 2022

She probably had Greece and Italy especially in mind, both with high legacy debt and a proclivity to plunge into extra borrowing when available.

But Ireland is not entirely in the clear either – the outstanding Exchequer debt stood at €226bn at the end of 2022, down only a little since the peak and a high figure relative to other EU members, according to the Department of Finance’s report on public debt a week ago.

The Government posted a budget surplus in 2022, strong tax revenues out-scoring a big rise in spending.

The Department worries that corporation tax receipts are at suspiciously high levels and may not be sustainable.

The “excess” annual corporation tax could be around €10bn, double the apparent budget surplus, which becomes a medium-sized deficit without the windfall.

Stamp duty

No doubt the officials in Merrion Street remember the plentiful inflow from stamp duty during the property bubble in the years leading up to the banking bust in 2008.

They made the budget figures look better than they really were, evaporated very quickly when the bubble burst and left the State unable to finance itself from 2010 onwards.

Today’s circumstances are very different but a small, open economy can be very volatile and is exposed to external events over which it has little control. The sudden contraction of a windfall tax source (corporation tax is now one-fifth of all Government revenue) contributed to the debacle in 2010 and there must be fears that another contraction could come at the wrong time.

Minister for Finance Michael McGrath, in a recent speech to Chartered Accountants Ireland, warned about the durability of receipts from corporation tax.

There is a persuasive case for a cautious approach to budgetary policy.