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Wednesday, 10th June 2026 |
| Another strong year in 2007 - but a less favourable external climate is forecast |
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By: John Beggs, John Beggs
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| The year ahead will see the continuation of strong domestically driven economic growth, helped by expansionary fiscal policy, writes John Beggs. However, life will be more difficult in external markets, he adds, as with the risks of higher interest rates, there is a need once again for companies to revisit their hedging strategies and ensure that they have appropriate protection in place, with the same being same true of currency market behaviour. |
The Irish economy performed very favourably in 2006. Real GDP grew by about 6 per cent, employment increased by almost 4.5 per cent and the government ran an overall surplus of 2.3 per cent of GDP. The economy enters 2007 facing a number of risks and uncertainties but the overall picture remains very bright. | | John Beggs |
The external environment will be somewhat less supportive in 2007 than in 2006. Global economic growth will be a little slower due primarily to weaker growth prospects for the US and the eurozone economies. However, the expansion in Asia will continue apace.
A key uncertainty in 2007 will be the trend in commodity prices, particularly oil and gas prices. Crude oil prices averaged $65.8 per barrel in 200. With steady supply and some reduced global demand, prices could dip to under$60 per barrel on average in 2007. This would help to dampen annual inflation rates in oil importing economies. It could also reduce the pressure on central banks to raise official interest rates further in 2007.
Central banks had been quite determined in 2006 to ensure that higher energy prices, which, of course, fed directly through into headline inflation rates, did not also spill over into higher core inflation rates.
As a result of this stance, the European Central Bank raised official rates by 1.5 percentage points to 3.5 per cent since December 2005; the US Federal Reserve raised US rates by another 1 percentage point, bringing the official Fed funds rate to 5.25 per cent. In the UK, the Bank of England raised official UK rates to 5 per cent by November.
Looking ahead, therefore, the prospects of lower inflation in 2007 should afford central banks the opportunity to focus more on the downside risks to economic growth rather than on the upside risks to inflation.
As regards the European Central Bank, it is clear that it remains concerned about the threat to inflation in the eurozone, particularly from the expansion in the monetary aggregates. Growth in real GDP was quite strong in 2006 at over 2.5 per cent, and the ECB appears confident about prospects for 2007. Under these circumstances, the ECB may continue to withdraw monetary accommodation. The official refinancing rate, therefore, could be raised to 3.75 per cent or even 4 per cent before the middle of 2007.
The ECB’s capacity to raise official rates in 2007 could be affected by the performance of the US dollar. Though the US currency has weakened towards the end of the year, the downtrend may not continue to any great extent into 2007. Currency market behaviour can be quite volatile, particularly towards the end of the year. For 2007, it is very likely that the US dollar will indeed be weaker than in 2006. The euro-US dollar rate averaged around $1.25 in 2006 and could average $1.32 in 2007. As regards euro-sterling, this rate is expected to stay within a narrow band of ?0.67-0.69 in 2007.
From an Irish perspective, the external economic outlook for 2007 can be characterised as somewhat less expansionary but with lower inflation. Monetary policy will be less supportive with higher official interest rates and a higher overall level of the euro. In summary, it will represent a more challenging competitive environment for Irish exporters. Irish industrial output and exports were relatively weak in 2006. It will be difficult for the export dependent sectors to improve on this performance in 2007.
Irish real GDP is forecast to grow by about 5.5 per cent in 2007, down from around 6 per cent in 2006. This forecast slowdown is largely due to the difficult prospects for the export sector. Domestic demand is projected to rise strongly in 2007 by about 6.5 per cent in real terms. Consumer spending will be the principal driver of domestic growth. Much of this expansion will be driven by the strength of the labour market and by solid per capita income growth. Employment has continued to grow strongly by around 90,000 in 2006, resulting in a very low unemployment rate. The sectoral distribution of employment shows how the gains are reasonably well spread with construction, health and education and financial services the main sources of growth.
The domestic economy will be cushioned in 2007 by two key supports. The first is the release of SSIA monies in the first half of the year. Though much of this overall savings fund may be retained and converted to other savings, it nevertheless provides a mayor support to consumer spending in the unlikely event of a serious shock to the economy.
The second important domestic support is the stimulus provided by the recent Budget for 2007. The government will inject sizeable support into the economy next year in the form of additional spending and lower taxes. This very stimulatory budget stance will offset some of the effects of higher interest rates.
The Irish housing market has been an important generator of domestic economic growth both directly through higher residential investment but indirectly through the wealth effect from rising property values. It has also resulted in one of the highest personal sector debt ratios in the OECD. Much of this growth in the housing market in Ireland has come from our remarkable growth in employment and from the doubling on national output over the past ten years. Though many will argue that we are overly dependent on construction, the reality is that we face major deficiencies in non-residential investment, particularly in relation to infrastructural projects. We must recognise that if we are to build a competitive economy, we must attain acceptable level of infrastructural investment.
Looking ahead, the rapid growth of recent years in residential investment is expected to slow down and may even go into modest decline by 2008. This should leave the door open for stronger expansion in non-residential investment.
It is important, however, in an economy with so much attention to property, both by the personal sector and increasingly by the business sector, that we do not lose sight of the need to expand our exports and develop our presence in external markets. A time will come in the not too distant future when our infrastructural development will no longer make a significant contribution to Irish economic growth. Ireland remains an export dependent economy. Our recent export performance has been relatively weak. Major domestic initiatives are required to improve our labour and non-labour cost base and to improve our productivity.
In summary, therefore, the year ahead will see the continuation of strong domestically driven economic growth, helped by expansionary fiscal policy. Life will be more difficult in external markets. With the risks of higher interest rates, there is a need once again for companies to revisit their hedging strategies and ensure that they have appropriate protection in place. The same is true of currency market behaviour. More people will understand that this is an area of considerable uncertainty. The prevailing view for 2007 is that renewed US dollar weakness won’t persist. However, this view could be well off the mark. The US current account deficit remains a major risk to the global economic system though there does not appear to be any great appetite to tackle it through currency adjustment. However, business should bear it in mind, particularly where currencies play an important role in their pricing decisions. |
John Beggs is chief economist of AIB Global Treasury.
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