| Economy: a temporary pause, not a prolonged slowdown |
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| Dermot O’Leary, top Economist for 2007, is not panicking about the expected downturn in Irish economic growth in 2008-9; ‘After such a period of record growth, and in particular, the domestically generated nature of this growth more recently, a slowdown was overdue’. |
The Irish equity market has picked up where it finished 2007. However, if one took the performance of the stock market as a gauge of activity in the Irish economy in 2007, this would not be telling the true story. Allowing for reasonable forecasting errors, economic growth in 2007 turned out pretty much as expected. National accounts data are only available for the first three quarters of the year, but these reveal that GDP (and GNP) grew by 6 per cent year on year. All areas of output were represented in the performance, with the consumer leading the way. For the full-year, GDP growth is estimated to be of the order of 5 per cent, in stark contrast to the 28 per cent decline in the value of the ISEQ.
More importantly, focus has long shifted to the forward-looking indicators for the economy, with most attention rightly being placed on the slowing housing market. The sustained period of low interest rates in the first half of this decade played no small part in Ireland’s increased dependence on residential construction. With tax incentives also present, this provided the perfect cocktail for the boom. Over the 2002-2006 period, housebuilding alone accounted for about 30 per cent of GNP growth. As a result, housebuilding output peaked at 13 per cent of GDP in 2006, relative to only 5 per cent in the US and 4 per cent in the UK. It was, clearly, unsustainable.
The speed of the rebalancing depended on a number of factors:
• The extent of the tightening of monetary policy
• The supply response from the construction industry
• The response of the financial institutions to a cooling market.
In order, base interest rates doubled, the supply response has been swift and the recent credit market turmoil has caused the banks to tighten up lending standards. The slowdown in the housing market, therefore, has been more severe than was initially suspected. As a result, the 35 per cent decline in housing completions will subtract significantly from Irish economic prospects in 2008. Furthermore, the continued low appetite for the commencement of new projects means that housing output could contract further in 2009 (-20 per cent expected), although there is still a large degree of uncertainty around this forecast.
Given the size of this sector, one would expect a slowdown of this magnitude to be feeding into other aspects of the economy. Indeed, we can blame some of the decline in consumer confidence on this very factor, but, as yet, this has not manifested itself in significantly lower levels of consumer spending; spending grew at a very healthy annual pace of 6.4 per cent in the third quarter of 2007, and probably grew by close to 6 per cent for the full-year. Nevertheless, lower employment growth and deteriorating sentiment will trigger a slowdown in consumption growth in the coming quarters.
Despite fears of a sharp cutback in Government spending, planned expenditure growth of about 9 per cent ensures that public spending will contribute to growth this year. Current expenditure growth was curtailed somewhat, but, unlike in the past, the Government has maintained its commitment to the full roll-out of Ireland’s physical infrastructure by announcing that capital spending will increase by 12 per cent. This is a sensible approach, and will ensure there are some countervailing forces at work in the construction sector, although the spending will not be enough to offset the residential slowdown in full.
Economies move in cycles, characterised by periods of above and below trend growth. In this regard, the experience of the Irish economy has been quite unique. If we take GDP as a measure of output, economic growth in Ireland hasn’t dipped below 4 per cent since 1993, a period of 14 years. After such a period of record growth, and in particular, the domestically generated nature of this growth more recently, a slowdown was overdue. A rebalancing away from the construction sector necessitates that growth be below trend in 2008 and, more than likely, in 2009 also. Nevertheless, the positive medium-term prospects for the Irish economy remain very much in place.
The economy has not yet felt the full effects of the housing downturn, but, as the slowing trend in housing begins to be reflected in completions and employment, this will feed through to economic growth data over the coming quarters. The coming two years will be a test of the resilience and flexibility of the Irish economy, but with government finances in good shape, net wealth of households among the highest in the developed world and demographics still favourable, the period is likely to represent a temporary pause, rather than a prolonged slowdown for Ireland. |
Dermot O’Leary is chief economist with Goodbody Stockbrokers.
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| Article appeared in the February 2008 issue.
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