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The outlook for the Irish economy remains favourable by comparison to our trading partners, albeit that growth is set to slow sharply. GNP growth in 2007 is estimated at 5% but will drop to 2% in 2008, still in excess of trading partners, but the slowest since 1991. A rebound to 4% in 2009 is predicted.
Activity will be heavily influenced by new house completions which we expect to fall to 45,000 this year with a minor recovery to 50,000 in 2009. The degree of uncertainty around these forecasts is greater than usual and 45,000 is best regarded as the centre of a fairly large range.
Consumer spending was buoyant in 2007, boosted by strong job creation, an expansionary Budget and a limited SSIA effect. However, a sharp deceleration to 3% is forecast for 2008, reflecting slower employment growth (0.9%) and more moderate wage increases (4%). Spending is likely to remain subdued in 2009. Unlike the US and the UK, there is no evidence here of home owners using mortgage equity withdrawal to boost consumer spending. The converse of this is that housing market weakness should have only an indirect effect on consumption via reduced employment in construction and less spending on items like furniture and hardware, which we have allowed for.
Inflation remained elevated in 2007 when the average CPI increase was 4.9%. The HICP, which excludes interest rates, was 2.8%, much lower but still well above the eurozone average of 2.1%. The 2008 forecast is 3.1% national and 2.9% HICP, closer to, but still above, the eurozone’s 2.5%. The 2009 outlook is for further falls in inflation.
The 2007 budget surplus was depleted by weaker revenue growth as housing slowed but remained in the black. The 2008 Budget posted a deficit of 0.9%, still comfortably below the EU 3% limit but is likely to overshoot as housing weakens further.
Housing affordability has improved as ECB rates are unchanged at 4.0% since June 2007, house prices are falling, stamp duty has been lowered, mortgage interest income tax allowances increased while wages are steadily rising. Supply has also been sharply curtailed but confidence has yet to recover. The house price index fell by 7.3% in the year to December 2007. We expect prices to fall further this year but to recover much of these losses in the second half. A modest rise is predicted for 2009.
Housing is still having a soft landing. House prices rose by 290% in the decade to 2006. They have since lost about 10% if allowance is made for the reporting lags in the house price index. The medium term outlook is for low single digit price increases.
While interest rates are forecast to remain unchanged there is an outside chance of a cut later in the year if growth in the eurozone slows sharply and provided the German wage negotiations result in pay rises that the ECB can “live with”. Our housing projections are based on unchanged mortgage rates. Overall, however, interest rate expectations, which have gotten quite bullish of late, are likely to be disappointed.
The outlook for housing and, with it, employment prospects dominate the Irish economy in 2008. Our July 2007 forecast for 30,000 job losses in a two-year period is still looking good and has recently been adopted by FAS, the official forecaster of the labour market. Similar job prospects underlie the forecasts in this quarterly.
At the same time, construction employment has held up better than might have been expected so far. This is because more than half of recent jobs growth has been voluntary part time, a sign, perhaps, of a reduction in labour supply as happened in 02/03. Large falls in employee jobs were also offset by a huge jump in the self-employed, most likely in construction repair and maintenance. This has probably now run its course and we expect to see steeper outright falls in construction employment from here on.
Construction employment is forecast to fall by 20,000 in 2008 but this will be outweighed by 40,000 new jobs in services, causing total employment to rise by 0.9%, still positive and above most other countries but the weakest Irish performance since 1992. A recovery to 1.6% growth is predicted for 2009.
The housing and employment forecasts have significant implications for investment and consumer spending. Our consumer spending forecasts are outlined above. Contracting housing output will drag total investment – which also includes commercial and civil construction as well as machinery and equipment - into negative territory. The last time this happened was in 2001 and before that in 1993. Our 2008 investment forecast is the weakest since 1983, reflecting the sharp response of the building industry to the slowdown. However, this is a positive as the sharper the fall in 2008, the bigger the rebound in 2009. The turnaround from large declines this year to a projected modest increase in 2009 is sufficient to cause total investment to recover sharply and GNP, in turn, rebounds to 4%.
Government spending on goods and services is decelerating from extraordinarily high levels but both the 2007 and 2008 budgets were expansionary to the tune of about 1.5% of GDP in each year. This, positive impetus to activity has been largely overlooked in the negative climate that now prevails. Weaker housing will cause the 2008 deficit to overshoot by a billion, bringing the forecast deficit to 1.4%.
There is little the Government can or should do about the current economic situation other that let the deficit rise if tax receipts weaken, so as not to exacerbate the situation by tightening fiscal policy as happened in 2001. The authorities should also ensure that the next pay deal reflects the lower inflation environment that is coming thereby helping to offset the loss of competitiveness from recent and prospective exchange-rate movements. In this respect, the second benchmarking report is a welcome indication of a more realistic approach to public sector pay.
Trade made a positive contribution to growth in 2006 and 2007 and we forecast this to continue in 2008 but to reduce sharply in 2009. Reports from the IMF that a US slowdown would have a major impact on Ireland seem to be wide of the mark. Our trade with the US is dominated by multinationals which give limited employment and import much of what they export, frequently priced off the market. Their net impact is also much-reduced when account is taken of profit repatriations, i.e. the appropriate comparison is GNP not GDP as used by the IMF. Moreover, the IMF study covers the period 1997 – 2006 so it reflected the dot.com boom which was potent for us both on the upswing and downturn. US investment has not had a significant net impact on Irish growth in recent years and is unlikely to have a major negative influence in coming years, barring a wholesale exodus of US investment which we do not anticipate. Irish GNP growth did not go below 2.5% during the last US recession earlier this decade.
Reduced housing activity has seen the rate of increase in mortgage credit outstanding fall off sharply. It ended 2007 at 13.4%, down from 24.2% a year earlier and a peak of 28.1% in March 2006. Further declines are in prospect with the rate likely to go below 10% in 2008. Gross new mortgage credit fell substantially in 2007 and 2008 is likely to see a repeat performance. Net credit growth, however, should remain in high single digit figures reflecting the purchase of 45,000 new homes, many with the assistance of a mortgage. Equity release lending fell back in 2007 from the very high level reached the previous year. It should, however, remain buoyant, helping to maintain overall mortgage lending.