In-depth review: Ireland
16 December 2015
Irish economy returns to ‘Celtic tiger’ growth rate.
The Irish economy now seems to be travelling with exceptional forward momentum. While an improving trend in GDP has been evident for some considerable time, the upswing remained unbalanced and tentative in many respects until this year. However the strength and spread of the recovery have become much more impressive through 2015. Importantly, the forces supporting this improvement seem likely to remain in place for some time to come. As a result, the Irish economy is expected to deliver clear gains in activity, incomes and employment in coming years. In turn, this should see Ireland’s public finances continue along a healthier path.
Global Skies Remain Cloudy but Important Silver Linings for Ireland
2015 has been yet another year in which early expectations that the world economy would move onto a notably stronger footing were disappointed. As international trade is crucial to the health of the Irish economy, it might be expected that these conditions would act as a major impediment to Irish growth. However, in several important respects, the Irish economy is being cushioned from the worst of the problems now facing the world economy.
Significantly, the US and UK economies have performed comparatively well through recent years and given a notable impetus to the Irish recovery both through their healthy demand for Irish exports and strong flows of foreign direct investment into Ireland. The associated strength of Sterling and the US Dollar has further boosted these positive influences.
Undoubtedly, the particular weakness of the Eurozone in recent years has weighed on Irish exports to these markets. However, this influence has been significantly offset by the impact of a very supportive monetary policy stance on the part of the European Central Bank (ECB). For an Irish economy with relatively high levels of private and public debt, the prospect of Eurozone rates remaining at historically low levels represent a significant support through the next couple of years. Although the emerging upturn in Ireland is unlikely to be credit driven, low borrowing costs will support some increase in lending. A more notable consequence is that low interest rates significantly ease the burden of existing indebtedness.
A further important favourable external development is the impact of low energy costs which may not attract the attention it deserves
. As diagram 1 below indicates, swings in oil prices have in the past been associated with significant changes in Irish economic performance in the past reflecting both direct effects on the Irish economy and the broader impact on global economic conditions. The drop in oil prices in the mid-80s coincided with the start of the upturn that became the ‘Celtic Tiger while the upward leg of a ‘super-cycle’ likely played some role in the intensity of the recent downturn. With net oil imports amounting to some 2.2% of Irish GDP, a roughly 35% drop in average oil prices in Euro terms this year represents a significant boost to Irish economic activity when both direct and indirect effects are considered.
Improvement in Domestic Activity Marks a Pivotal Point in Irish Recovery
GDP data suggest that the Irish economy has been in recovery mode since the first quarter of 2010. However, until recently, the emerging upturn has been concentrated on exports. As exports amount to some 114% of GDP, this proved sufficient to put the Irish economy on a solid growth path. Moreover, as the recent downturn largely reflected the reversal of an unsustainable trajectory in domestic spending, an export led upturn was the preferred form of turnaround. The combination of favourable external conditions, improved competitiveness and a persistently strong pipeline of Foreign Direct Investment into Ireland has translated into extremely strong growth in Irish exports. We now expect exports to grow by around 10% in 2015 which, with the exception of 2014’s 12% increase, would be the strongest performance since the year 2000. Reflecting a still mixed global environment, we expect a significant moderation in export growth next year to a still robust pace of about 6%.
Important as export growth is to the health of the Irish economy, the significance of the recent revival in domestic spending should not be underestimated. After a prolonged and painful adjustment, a healthy trend in domestic demand which corresponds more closely to the experience of most Irish consumers and firms is crucial to social stability, particularly with a general election due within the next four months. It is also important to the performance of Ireland’s public finances.
Domestic spending did not show a clearly improving trend until the second half of 2014, more than four years after the initial improvement in Irish GDP. So, 2015 has been the first year in which signs of recovery became widely established across the Irish economy. The turn is still quite uneven across different parts of the country and across business sectors. However, a range of indicators suggest it is building and broadening as we turn into 2016. Critically, the data in diagram 2 below highlight the extent to which recovery has now become broadly established.
For the first three quarters of 2015, the year-on-year growth rate in GDP is running at 7%. Consumer spending is picking up notably while out-sized export growth is continuing. With house-building up just 11.3% and overall construction up just 0.9% in the third quarter of 2015 from a year earlier, these data also underline the supply issues that continue to underpin rapid property price inflation. The robust health of the multinational sector is seen not only in exports but in the associated buoyancy of imports and net factor flows. So, it would seem the Irish economy is firing on nearly all cylinders as 2015 draws to an end.
Our forecasts for the full year of 2015 assume some increase in imports in the final quarter, but this should be significantly offset by additional public spending and a re-invigorated Irish consumer. As a result, GDP should grow by around 7.2% for the year as a whole, which would represent the fastest pace of growth since the year 2000. For 2016, GDP growth may ease to about 4.5% largely reflecting some slowdown in export growth as domestic spending should continue to grow strongly. Spending on capital equipment could remain particularly buoyant. We think that revised public spending plans will translate into solid increases in day to day government spending and public investment. Our forecasts for the main spending components of GDP are set out in detail in diagram 3 below.
On our reckoning, additional public spending will impart a substantial direct and indirect boost to the Irish economy in the final stages of this year with a significant carryover effect through 2016. We reckon fiscal measures will impart a boost of about 1.5% of GDP to the Irish economy in 2015 and around 1% in 2016. However, the most notable aspect of the upswing at present is the strength of growth in numbers at work and the associated drop in unemployment which is driving a marked turnaround in consumer spending.
Jobs Growth now the Main Driver of Domestic Upswing
The remarkable turnaround in the Irish jobs market is clearly seen in diagram 4 below. This highlights the severity of the downturn in terms of the decline in numbers at work and the rise in unemployment and the extent of the more recent recovery. The latest data relate to the third quarter of 2015. They show numbers at work were 56k or 2.9% higher than in the third quarter of 2014. Full-time employment climbed by 59k or 4.1%, the fastest pace since late 2006 and unemployment dropped to 8.9% in October, the lowest rate since December 2008. As well as the current buoyancy of activity, the current rapid pace of Irish jobs growth likely owes something to a correction of what now looks to be an overshoot in terms of the scale of job losses through the downturn. Following a drop in employment of 327k or 15.1% between the early 2008 peak and the mid-2012 trough, numbers at work have recovered by 140k in the past three years.
Reflecting sustained strong jobs growth, the unemployment rate has fallen from a peak of 15.2% in January 2012 to 8.9% in November 2015. In turn, the long term unemployment rate has fallen from 9.5% of the workforce in early 2012 to 5% in the third quarter of 2015. This momentum suggests unemployment could drop below 8% by the end of next year. Improvements on this scale are broadly consistent with expectations of out-sized growth in Irish GDP.
Wage Growth Now Turned Positive
A strong jobs market is the key driver of growth in Irish household incomes and, consequently, of personal spending at present. The direct boost to the spending power of the newly employed is central to this influence but the related improvement in confidence as fears of job loss ease and expectations of wage growth build is also important. As yet, there are few signs of any marked pick-up in economy-wide pay even if there are increasing suggestions of staff shortages in some areas. The relatively recent vintage of the recovery and exceptionally low inflation—courtesy of a sluggish global economy and weaker commodity prices as described earlier—are important influences in this regard.
After several hours of declining wages, average hourly earnings increases moved into positive territory in late 2014 and showed an increase of 2.1% in the third quarter of 2015 from a year earlier, rising in 10 of 13 sectors. Overall, private sector hourly earnings climbed 2.8% while the influence of the ‘Haddington Road’ agreement between the Government and public sector unions and a changing age/experience profile contributed to a 0.2% decline in public sector earnings.
End of Austerity Hugely Important
Alongside the strengthening jobs market, a key factor contributing to the turn in domestic economic activity is a notable change in the stance of fiscal policy. The nature and implications of this shift are central to an assessment of the path of the economy and the public finances in the years ahead.
Scope for a shift away from austerity measures to a fiscal stance encompassing some support to activity has begun to appear because progress in addressing problems in Ireland’s public finances in recent years has surpassed even the most optimistic of expectations. As diagram 5 below shows, Government borrowing excluding costs arising from support to the financial sector fell from a peak of just under 12% of GDP in 2009 to 8% of GDP by 2012 and progressively each year to 6%, 4% and about 1.5% of GDP in 2015. We think next year’s out-turn should be slightly less than 1%, with a broadly balanced fiscal position attainable in 2017.
The combination of markedly lower Government borrowing and rapid increases in GDP have resulted in a substantial reduction in public debt which has fallen from a peak of 123% of GDP in 2013 to an estimated 97% of GDP by the end of this year. The current strong performance of the Irish economy means the current trajectory of the denominator in this ratio is now moving along a very favourable path. By boosting tax revenues and restraining cyclically sensitive public spending, that same economic strength is also restraining increases in the numerator.
These developments mean that a notably positive dynamic is now taking hold and the sharp worsening in Ireland’s debt metrics has begun to reverse. The prospect of sustained solid growth in the next couple of years could deliver a notable drop in the debt to GDP ratio through this period. This should be further assisted by a number of financial developments. Some reduction in the funding ‘war-chest’ of the National Treasury Management Agency may be considered. More important is the likelihood that part of the Government’s holding in AIB will be sold within the next twelve months and possibly much sooner.
These various influences could cause Ireland’s debt to GDP ratio to slip to 90% next year. As a result, Ireland’s deficit and debt ratios should both slip below respective Euro area average which the IMF currently estimates at 1.7% of GDP and 92.8% of GDP in 2017 and a further marked improvement appears to be in prospect for 2017 and beyond on the assumption that a reasonably robust growth rate can be sustained.
The strong progress now achieved in terms of Ireland’s public finances does not mean that fiscal concerns are no longer centrally important to the Irish economic outlook. However, it can be suggested that they need no longer be the only focus of domestic policy-making. After a prolonged and painful fiscal adjustment totalling some 17% of GDP, there are strong arguments on grounds of economic and social cohesion that fiscal policy now needs to signal that those efforts have been successful and that scope has been created for some easing in the associated burden.
It is important to note that some element of fiscal support for activity can be rationalised on economic grounds even in an Irish economy growing at about 7% in 2015. Exceptional as the current pace of growth may be, account must be taken of the severity of the recent recession and the idle capacity it generated. Although GDP is now about 5% above its pre-crisis peak, household income is still 9% below its previous peak. The upswing has strengthened of late but its extent varies widely across parts of the country and economic sectors. Unemployment at just under 9% is more than twice its pre-crisis level and probably understates the true extent of ‘slack’ in the economy given reduced participation in the jobs market and increased emigration.
We don’t think a calibrated fiscal boost will lead to runaway inflation. A broadly based disinflationary impulse seemingly embedded in the global economy further suggests the risks of generalised overheating seem fairly limited. With significant underutilised capacity in the Irish economy, consumer prices are likely to remain subdued–probably rising by about 1% next year although rapid inflation may persist in specific areas such as rents, insurance and education.
It is also important to emphasise that EU fiscal rules markedly reduce the threat that the Irish public finances might return to a threatening path. As Government borrowing should be close to 1.5% of GDP in 2015, the outturn will comfortably beat the target of a deficit below 3% this year. As a result, Ireland now moves from the corrective
phase of EU fiscal rules to the preventive
phase in 2016. Progressive improvements in the underlying or structural
deficit of at least 0.6% of GDP will be required each year. Budget 2016 envisages a cut of 0.8% of GDP in this measure which should be associated with a revised headline borrowing target of less than 1% of GDP next year. In turn, expectations are building that a return to broad balance can be achieved in 2017, a year earlier than previously envisaged.
In a sense, the EU rules also contributed to a step-up in public spending in late 2015. This is because the preventive phase of these rules also requires that public spending increases less than the economy’s potential growth rate. As this constraint only takes effect next year, it created an incentive to boost public spending in late 2015 thereby boosting the base from which future increases will be calculated. While such actions may contradict the spirit of the EU rules, the letter of the rules is likely to encourage such developments. Importantly, this spending boost is a once-off and the new rules may prove a significant constraint on Irish public spending in future years.
Property Markets Recovering But Supply and Policy Issues Persist
The speed, intensity and uneven nature of the turnaround in Irish economic conditions have all been reflected in both the residential and commercial property markets. The return of solid demand coupled with much diminished supply has resulted in a marked rebound in property prices. Not surprisingly, this has sparked some concern that another boom bust cycle is in the offing. While recent history warns against complacency in this regard, there are good arguments why prices have come under sustained upward pressure once economic recovery began. In this context, diagram 6 relates the trend in Irish house prices to developments in the jobs market.
The recent EU commission ‘Growth Survey’ for 2016
suggests Irish property prices were about 20-25% undervalued at end 2013. While their valuation model isn’t specified, the increase in official price data in the interim might suggest that Irish residential property prices may be still marginally undervalued (EU Commission Alert Mechanism Report 2016 p16).
Encouragingly, while positive monthly changes in each of the past eight months suggest continuing strength in the property market, the annual rate of increase over the same period has moderated from 16.8% in March 2015 to 7.6% by October. Improving domestic economic conditions and a shortage of property in key market segments seem to be offsetting the restraining influence of recently introduced credit limits.
The strength of the Irish economy should continue to underpin the property market in coming years. However, the interplay of significant supply shortfalls in key market segments and macro-prudential constraints on credit hugely complicate the picture for 2016. We reckon a sustainable pace of house price inflation is likely to run in a 3-5% range in a healthy Irish economy in coming years but the path to such an outcome may remain quite bumpy.
Political Uncertainty May Increase Somewhat Ahead Of Imminent Election
It is understandable that much of the discussion on the recent loosening of Irish fiscal policy emphasises the role played by political considerations in this development. A general election must be held by April 2016. So, it is understandable that political factors influenced the thrust of Budget 2016. As noted above, political and economic considerations coincided rather than conflicted in terms of the policy stance adopted in the Budget. In common with the experience in other countries, a difficult and extended adjustment programme has taken some toll on support for mainstream political parties. However, a broad social consensus on the appropriateness of such an adjustment has been sustained in Ireland and should be reinforced by the recent Budget.
The relatively recent turn in domestic spending power and a still significant reduction in living standards mean the current coalition Government made up of the centre right party, Fine Gael, and the centre left party, Labour, is likely to suffer a significant drop in support in the upcoming election. At the time of the previous election, this coalition commanded the support of some 55% of the electorate. Recent opinion polls show some recovery in the standing of the Government parties to their best rating since early 2014 but at 39%, this still falls some way short of an overall majority. The key unknown is whether the positive impact of various tax and welfare changes made in the recent Budget (and set to take effect at the start of 2016), coupled with the lack of a clear alternative to the present coalition will influence voting intentions between now and polling day.
There has been some market commentary expressing concern at the possibility of a shift in Irish economic policy in the event that Sinn Fein (currently on 17% support) or some left wing independents with more radical economic views held a balance of power after the next election. However, the risks of a material change in what has been a very successful, longstanding and broadly supported approach to Irish economic policy look very limited. Nonetheless, such concerns could attract some attention in the months ahead. Significant changes to electoral constituencies and a reduction in the size of the Dáil (Parliament) as well as the relatively large numbers of undecided voters in recent polls may further add to uncertainty in this regard in the near term.
Growth Can Remain Strong but Reducing Cyclical Swings A Key Issue
The strength of the recovery in the Irish economy in 2015 owes something to unusually rapid growth in exports that may exaggerate the turnaround in broader conditions across the economy as a whole. However, the most notable feature of the recovery at present is that turn in domestic conditions. As diagram 7 below which compares the historic growth picture in Ireland with that of a more ‘mature’ French economy indicates, the broader picture remains one of large cyclical swings around a comparatively strong trend growth dynamic. In turn, that dynamic remains founded on the exceptional flexibility of the economy complemented by a comparatively favourable demographic. We remain of the view that the potential growth rate for the Irish economy lies in the region of 3% but after a 2016 outturn which we expect to be in the region of 4.5%, we think growth could average slightly above 3.5% for the following couple of years
as household and capital spending curtailed through the downturn re‐emerges.
Turning to potential sources of risk,
a still uncertain global backdrop
represents a significant source of downside risk in relation to the Irish economic outlook given the openness of the Irish economy. More generally, we continue to see challenges in moving the Irish economy onto a sustainable trajectory or ‘safe speed’.
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.