Tánaiste Leo Varadkar has said that pay rises are not a solution for inflation and has called for an anti-inflation strategy to reduce the cost of living.

Mr Varadkar made the remarks during a virtual address on the future of Ireland's industrial policy to the Institute of International and European Affairs (IIEA).

He said that he agreed with the ESRI's assessment that the current spike in inflation is not temporary.

"It could go on for two years or more. It requires a long-term response as well as temporary measures," he said.

Mr Varadkar said that while pay rises and increases in pensions and social welfare will be needed to compensate people at least in part for the higher cost of living, it is not a solution to inflation.

"Many businesses will simply fund pay rises by increasing what they charge customers for goods and services, thus wiping out the gains," he said.

The Tánaiste called for a comprehensive anti-inflation strategy that includes continuing to reduce the income tax burden on middle-income earners, reducing the cost of services, strengthening competition and consumer laws, accelerating the transition away from fossil fuels and scaling up social housing construction.

On tax, Mr Varadkar said he has asked the Minister for Finance to examine the viability of a new 30% tax rate for middle-income earners.

He said that the Government was looking at other ways of compensating people for rising energy costs, but that this would be done in coordination with the European Union.

Asked about price caps for fuel, Mr Varadkar said he believed they could make it unviable for traders to operate and may not have the desired effect of driving costs down.

Earlier today, Mr Varadkar said inflation is down to international factors that are beyond the Government's control but said it is trying to "ease the pain".

His comments come after the Economic and Social Research Institute lowered its forecasts for growth in the economy this year and increased its outlook for inflation as a result of the ongoing war in Ukraine.

The Tánaiste said any further actions like a reduction of VAT would be taken at a European level.

Sinn Féin Leader Mary Lou McDonald said inflation is resulting in families struggling to keep their heads above water as the cost of living soars.

She said impact of the "criminal war" means that families are struggling to put food on the table.

Sinn Féin called on Government to act and not stand idly by as people are pushed into poverty.

She said people cannot wait until the Budget for measures to bring down the cost of living.

Mary Lou McDonald again asked Government to remove VAT from energy bills for three months and to cut excise duty on home heating oil.

Responding, Public Expenditure Minister Michael McGrath said these are unprecedented times and the level of inflation which people have to deal with is unparalleled in modern times.

He said the Government has already responded with decisive measures outside of the normal budgetary calendar but can't fully insulate homes and businesses from inflation.

The Minister said there were no immediate plans for further measures, but he added that the Government was engaging with the European Commission on the VAT issue and expects to hear back from the Commission shortly.

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ESRI says inflation could peak at 8.5% this summer

In its latest Quarterly Economic Survey, the ESRI said inflation could peak at 8.5% this summer before averaging out across the year at 6.7%.

The average 6.7% inflation rate forecast for this year by the ESRI would be the highest annual rate since 1984.

The Russian invasion of Ukraine will have a negative impact on global economic activity and is making inflationary pressures, which were already building, even greater.

The ESRI also warns that its latest forecasts for the economy are highly uncertain with big downside risks due to the ongoing war.

It has pared back its forecast for growth in the economy this year to 6.2%.

But even given all of the uncertainty, the ESRI still believes there will be a small surplus in the public finances for the first time in three years.

However, inflation poses a serious problem with disposable incomes likely to fall on average by between 2-3% as wage increases are overtaken by higher prices.

It believes more measures to protect those on lower and fixed incomes may be necessary.

The think-tank also said that if the Government chooses to use it, the Covid contingency fund would provide some cushion against inflation and provide for humanitarian assistance to those fleeing the war in Ukraine.

The war in Ukraine has led the ESRI to reduce its forecasts for economic growth this year to 6.2% in GDP terms and 5% when measured by Modified Domestic Demand.

This compared to a forecast in its Winter Quarterly in December of 7% growth in GDP and 7.1% growth in MDD.

Inflation had been forecast to average at 4% this year, but that has been revised upwards to 6.7% with a possible peak of 8.5% in June or July.

However, ESRI Research Professor Kieran McQuinn cautioned that there is "a lot of uncertainty around those figures" and that inflation could prove to be "even more acute than that".

The ESRI is forecasting a small surplus in the public finances of €1.1 billion, or 0.2% GDP, this year compared to a previously forecast deficit of €4.8 billion, or 1% GDP.

But Professor McQuinn said "there are significant downside risks for the public finances" if the need arises for further Government assistance to low-income groups or support for specific sectors of the economy, such as agriculture, which might be adversely affected by the ongoing war.

The report notes that only 6% of Ireland's petroleum imports come from Russia, but it accounts for 67% of our coal imports and 26% of fertilisers.

It also notes a "reputational risk" from an estimated 70 firms registered in the IFSC holding €62 billion in assets with Russian connections.

But it said these are neither owned by Irish institutions or households.

It calculates the Irish financial system's direct exposure to Russian lenders at under $2m, which it describes as "minimal".

Speaking on RTÉ's Morning Ireland, Professor McQuinn said that inflation pressures were expected to be temporary in light of the pandemic, but now recent events will "exacerbate" the pressures and will mean higher inflation for the rest of the year and possibly into 2023.

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He said energy markets as well as commodity markets are affected and foodstuffs will increase in cost.

"Ukraine and Russia are amongst the largest producers of wheat in the global market, so this is all going to feed into, unfortunately, higher inflation really certainly for the rest of this year and probably well into 2023," he cautioned.

Household consumption will be affected, and people will spend less on discretionary items, he added.

Mr McQuinn said the economy has come through the pandemic in a "relatively robust and resilient manner" and it is still expected to grow but ultimately the war in Ukraine will impact that growth.

The public finances are "in reasonably good order" and although there was significant borrowing in 2020 the strength of the economic performance has meant that all key fiscal indicators are on a sustainable trajectory again, he said.

The ESRI has recommended that any Government support measures be targeted to households that need them the most as "that's the most effective way to alleviate the inflationary pressures", he said.

If the inflationary pressures continue to build, and if they are more acute than expected then a mini-budget may be needed "but it inevitably will depend on the scale of the inflationary pressures in the economy ultimately", he added.

Additional reporting: Maggie Doyle, Robert Shortt, Mícheál Lehane