It's your Mortgage Day!
Business volumes and employment show continued growth at end 2015.
Domestic activity accelerates while manufacturing growth eases.
Domestic costs continue to build; increases across widest range of firms since 2008.
Output growth among Irish based companies consistent with 7% GDP growth in 2015.
Wages to rise in 8 out of 10 companies in 2016 with just over half of pay rises less than 2%.
54% of firms don’t see direct impact on their business from ‘Brexit’ but 42% fear negative effects and only 4% see positive consequences.
Increased economic uncertainty cited as key risk from ‘Brexit’ by 67% of firms with greater currency fluctuations ( 54%) and increased costs of doing business with UK (38%) also problematic.
A combination of stronger activity levels at reporting companies and increasing optimism about the broader Irish economy meant Irish business sentiment reached a new nine year high in the final quarter of 2015. The improvement in the sentiment index in the last three months was relatively modest but fairly broadly based. This hints that the economic recovery continues to spread further across the various sectors of the Irish economy but the pace of economy-wide growth appears to be stabilising rather than continuing to build.
The KBC Bank Ireland/Chartered Accountants business sentiment index increased to 131.1 in the final quarter of 2015 from 130.8 in the previous quarter. While this was a relatively modest gain, as diagram 1 shows, it was sufficient to push the index to the highest level since the survey began in 2006.
Activity levels across firms operating in the Irish economy continued to increase as 2015 drew to a close but, as diagram 2 indicates, the pace of growth was only fractionally ahead of the previous quarter. With two thirds of companies signalling increased business volumes and less than 6% indicating weaker activity, the survey suggests a very broadly based upswing is now evident across Irish based companies.
The most notable development through recent quarters is the increased positivity of businesses focussed on the domestic economy. The latest survey shows the most broadly based gains in activity were in sectors such as those serving Irish consumers, construction and the food industry. In each instance, around three quarters of respondent firms reported stronger activity of late with only in the region of one in twenty indicating lower business volumes. So, the survey suggests the emerging recovery in domestic demand is spreading markedly.
In contrast, output increases in manufacturing companies- while still very clear-cut- were less widespread than previously reported. This is not entirely surprising in that it reflects both that this sector is at a later stage of the upswing than most others and the rate of growth recorded by these firms in recent years has been exceptional. It may also reflect something of a correction after comparatively strong responses from firms in this area in the previous survey. However, these results may also hint at some scaling back of output growth in response to a more uncertain global outlook of late.
As manufacturing firms also report solid hiring and strong expectations for future business, at this point these results suggest the prospect of some easing in the pace of economy-wide growth rather than any marked weakening in economic conditions. That said, they highlight one significant source of risk to the outlook for the Irish economy as 2016 begins.
As diagram 3 indicates, a broadly similar picture of widely based growth in activity levels is envisaged for early 2016. Two thirds of companies surveyed expect their business volumes will increase further in the first three months while only one in twenty five envisage cutting production in the coming quarter.
While this is the strongest expectation in the nine years of the survey, it represents only a marginal change from companies’ experience of the most recent quarter or the expectations they outlined (and which were largely borne out) in the previous survey. We think the pace of economy-wide growth suggested by this reading is probably above what might be considered ‘normal’ but it seems consistent with a further period of ‘catch-up’ after a severe and prolonged downturn.
With business activity levels now set on a strong trajectory for a significant period, it is scarcely surprising that firms are continuing to add to their capacity by increasing their workforces. Again, the evidence of diagram 4 suggests that jobs growth in late 2015 continued at the strong but steady pace seen in the previous couple of quarters. With business volumes growing at a fairly consistent pace, it is not entirely surprising that payrolls are being scaled accordingly.
Broadly similar strong jobs balances were reported across all sectors, emphasising the widely felt nature of the improvement in the Irish labour market at present. Although respondents are asked to allow for seasonal influences, the somewhat stronger incidence of hiring reported by food and consumer oriented firms may reflect some influence from Christmas related activity.
Encouragingly, in spite of slightly softer activity growth, manufacturing firms also reported marginally larger than average number of firms reporting job growth in the final quarter. In contrast, construction and other property firms reported modestly weaker than average hiring growth, possibly reflecting a range of difficulties these sorts of firms are facing in right-sizing their businesses in the face of rapidly changing market conditions in recent years.
One potentially concerning aspect of the 4th quarter survey is a further uptick in the number of firms reporting an increase in costs in the past three months. Diagram 5 shows that 48% of Irish based firms saw their costs increase in the final quarter of 2015 while just 5% experienced a fall in costs. This represents the poorest cost outturn since the third quarter of 2008 when a spike in oil prices to nearly $145 per barrel were boosting costs worldwide. With oil prices now tumbling and international inflation extremely low, a sustained rising trend in domestic costs could become a significant impediment to the persistence of strong growth.
The main drivers of the increase in the cost element of the sentiment survey were more widely felt increases in costs in manufacturing and in the food sector. In contrast, the incidence of cost increases eased marginally in the past three months in areas such as construction, business services and consumer focussed companies although all of these sectors continue to report fairly broadly based rises in costs.
Our judgement is that the emerging trend in Irish business costs bears watching but we must be careful in interpreting its implications. After a major adjustment in Irish costs through the downturn, it would scarcely be surprising if as recovery becomes established that in some areas an overshooting to the downside was at least partly reversed. Similarly, the pattern of wage growth in a rapidly growing Irish economy with unemployment below 9% could be expected to be somewhat different to that in a crisis economy with unemployment at 15%. Finally, Irish based companies importing goods or services from the US or UK might in some instances see a significant impact from the weaker exchange rate of the Euro. For all these reasons, some increase in Irish business costs is to be expected. The key question is whether recent developments hint at a potentially threatening rise. (We examine the issue of costs further in some of the supplementary questions examined in section 2 of this note)
Against a backdrop of strong conditions in their own businesses and a sequence of extremely strong macroeconomic data, it is scarcely surprising that companies were generally very upbeat about the broader Irish economy. However, as diagram 6 shows, results in this area were fractionally weaker than those of the previous survey. This reflected slightly larger- albeit still very limited-numbers of companies that were less optimistic than in the previous survey. These occurred in manufacturing, where an uncertain global backdrop could be an issue, and in consumer related companies, where it might be speculated that the persistence of intense competition and heavy price discounting are influencing the assessment of the current ‘macro’ environment.
While there is broad agreement that the Irish economy performed very well in 2015, there is significant disagreement as to precisely how strong the pace of economic growth truly was. Irish national accounts data are far from unique in incorporating a range of statistical adjustments that are often seen distancing the measured growth rate in GDP from the experience of the majority of businesses and households. While the official data properly reflect best international practice in measuring aggregate economic activity, we thought it might be interesting to ask companies how much their output had increased in 2015. Importantly, these results reflect a view across the range of companies based in Ireland rather than a weighted average of their output (in rough terms this means the measure we arrive at is closer to the mode rather than the mean).
As diagram 7 indicates, roughly a third of companies say their output rose faster in 2015 than current estimates that put GDP growth close to 7% whereas only about a quarter say their activity levels increased at a notably slower pace. Using some very crude assumptions (that 12% was the average growth rate of companies growing faster than 10% and 0 was the average growth of those growing less than 2%), it would seem that the representative growth rate across all Irish based companies in 2015 was about 6.6%. This admittedly very rough calculation suggests that for the average Irish company, current estimates of GDP in 2015 of about 7% is not wildly different from the experience of many.
Inflation in most advanced economies has been extremely low of late and a further down-leg in commodity prices seems likely to prolong such conditions. We thought it might be interesting to examine current trends in Irish business costs in a little more detail particularly as the previous survey hinted at some increased pressures in this area. As noted above, the 4th quarter survey saw some further upward pressure on Irish business costs. So, our examination of this area may be timely.
Diagram 8a shows that very few Irish based companies operate in markets characterised by rapid inflation. Indeed, while 31% say they are operating in conditions of modest inflation and 9% in circumstances of disinflation (slower increases in prices), more than half of the companies surveyed say the trend in selling prices is flat (45%) or downward (14%). Downward pressure on prices was more common in areas such as manufacturing, food and consumer facing businesses while price increases were more prevalent in areas such as construction. So, the broad selling environment is not conducive to significant cost increases.
Diagram 8b sets out the areas where there is clearest upward pressure on costs. About a third of companies surveyed show either no clear increase in costs or similar increases across all categories. However, a clear majority (some 55% of respondents) indicated that wages were the area of costs under most upward pressure. This tendency was most pronounced in firms in manufacturing and food- areas that traditionally would be regarded as particularly exposed to international competition. As noted in section 1, this development bears watching but it remains unclear at this point whether we are seeing a healthy ‘normalisation’ of costs as the Irish economy recovers or a more threatening deterioration in Irish companies’ competitive position.
One admittedly crude way of assessing the consequences of rising Irish costs is to look in a little more detail at the scale of increases envisaged in labour costs. Diagram 8c suggests that about 8 in ten Irish based companies expect their average pay rates to rise in 2016. Of this number, just over half (42% of those surveyed) envisage increases of less than 2% while just slightly fewer (38%) anticipate average pay rising by between 2 and 5%.
Only a negligible 3% of companies expect average pay to increase by more than 5%. So, relatively modest pay increases appear to be the norm. Interestingly, food, manufacturing and construction companies show a greater tendency towards pay increases over 5% or between 2 and 5%. These same areas also reveal a greater tendency towards larger pay increases in 2016 than in 2015.
With an increased focus on the upcoming UK referendum on EU membership, we also included a number of questions on this topic in the 4th quarter survey. As diagram 9a indicates, just over half of the companies surveyed feel ‘Brexit’ would not have a significant impact on their business. Of the remainder, the vast bulk (42% of overall responses) envisages a negative impact whereas very few (4% of overall responses) see a positive effect on their business.
While food and construction companies tended to be comparatively negative in their assessments of the possible consequences, there were no results unique to specific sectors. Indeed, in areas such as consumer focussed businesses the incidence of both negative and positive verdicts on the likely impact of ‘Brexit’ was above average, suggesting company specific considerations are quite important. More generally, however, the consistency of results across sectors suggest that companies feel ‘Brexit’ would be an economy-wide shock rather than a development limited to particuar sectors. This is consistent with the responses to other questions set out below.
We also asked companies to indicate the various ways in which ‘Brexit’ might affect their business. The responses shown in diagram 9b reflect the proportion of respondents highlighting each issue (hence, the shares don’t sum to 100). Not surprisingly, in view of a range of uncertainties that surround the likely manner and aftermath of the UK’s potential departure from the EU, increased economic uncertainty was mentioned by two thirds of respondents. As this clearly exceeds the number who judged ‘Brexit’ would have an adverse impact on their business, this implies a strong sense that the broader consequences may be more problematic than the specifics.
Given that Sterling is already freely floating against the Euro, the relatively widespread view (54% of responses) that exchange rate volatility might increase may reflect particular concerns about dramatic event centred currency movements such as those that followed the UK’s departure from the EMS in 1992. The prospect of a significantly increased administrative burden in relation to trade with and travel to the UK no doubt explains the significant concern (expressed by 38% of respondents) in relation to increased transaction costs of doing business with the UK.
Other responses to this question indicate ambiguous but notably less widely held views that if the UK left the EU it would open up both opportunities and threats in terms of the location of international businesses and the focus of such operations. While responses to the survey show these to be significant, the general tone of the survey suggests Irish business is of a view that they are likely to be overwhelmed by adverse ‘macro’ consequences.
This non-exhaustive information is based on short-term forecasts for expected developments in the economy and financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalised investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a judgment as of the date of the report and are subject to change without notice.