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Tuesday, 16th September 2025 |
| Significant fall in the dollar is the biggest threat facing Ireland |
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| The risk of a very significant fall in the US dollar against other major currencies constitutes the single biggest threat to the Irish and European economies this year writes JOHN BEGGS. However, while he envisages some weakness in the dollar this year, its decline against the euro is likely to be limited to below the $1.30 level, he says. Overall, he is very optimistic about the outlook for the economy. |
The performance of the Irish economy continues to impress. In overall terms, economic growth remains firm, employment has grown significantly, we are at full employment, the public finances are in excellent shape and inflation remains relatively low. In contrast with many of our European neighbours, Ireland does not suffer from any serious internal or external imbalances. Of course, we still require a sustained and major investment in infrastructure in order to bring our economy up to more competitive standards and like many other OECD economies, we face the serious challenges from China and other Asian low cost competitors.
Most commentators now estimate that the Irish economy grew by around 4.5 per cent last year, broadly the same as in 2003 and 2004. Growth in the economy in 2005 was very much driven by domestic demand. Both consumer spending and fixed investment rose strongly last year. Exports, on the other hand, performed poorly.
Consumer spending grew by about 5.7 per cent in real terms in 2005. This was the principal source of economic growth last year. This was slightly below the estimated growth in real personal disposable income of 5.8 per cent so the personal savings ratio rose once again to about 13 per cent from 12.8 per cent in 2004.
Investment spending also made a sizeable contribution to GDP growth in 2005 but unlike 2003 and 2004, when housing was the largest component, most of the contribution in 2005 came from spending on machinery and equipment. Total investment spending increased by over 9 per cent in 2005, compared with 8.2 per cent in 2004 and 5.6 per cent in 2003.
It is clear that while overall Irish economic performance is solid, there are some problem areas in the economy. Manufacturing is under continuous pressure from rising domestic costs and intense international competition. These factors adversely affected both output and merchandise export performance in 2005.
There has also been a weakening in service exports in 2005. Looking ahead, sustained Irish economic expansion will require more balanced growth with a solid contribution from our internationally traded sectors.
Turning to the current year, there is a striking consensus amongst forecasters that GDP growth will accelerate modestly to 4.75 - 5.0 per cent in 2006. The external environment is expected to remain favourable, with a pick up in growth in Europe forecast for the coming year.
On the domestic front, fiscal policy will be expansionary again this year. The backdrop for the 2006 budget, delivered in December last, was the most favourable a Minister of Finance has faced since the era of the Celtic Tiger. The Minister was able to deliver a relatively generous budget and still target just a small General Government budget deficit of 0.6 per cent of GDP in 2006. Indeed, the eventual outturn could be closer to balance in 2006. The income tax cuts were the most generous since 2001, costing ?681 million in a full year. They should help ensure continued strong growth in labour supply and could have a positive impact on the upcoming pay talks. Increases in indirect taxes were avoided, which will help sustain the low inflation environment, helping competitiveness.
The Irish headline rate of inflation is under upside pressure from higher energy prices and higher mortgage costs. However, disinflationary forces also remain intact as international competitive pressures and technological changes continue to exert downward pressure on many of the goods components of national CPIs. It is imperative that forthcoming pay talks, whether national or otherwise, fully recognise the transient nature of any increases in Irish inflation, which has fallen back in recent months. The medium term outlook is for a moderate underlying inflation rate of 2.5 per cent or less.
Although interest rates are now rising, monetary policy is expected to remain accommodative, as just a modest increase in official rates is anticipated in 2006. Most of the anticipated rise in rates should occur in the first half of the year. By June, the official ECB refinancing rate could have reached 2.75 per cent.
Consumer spending is expected to be the main engine of economic growth in the coming year. SSIA accounts will start to mature from mid-2006 onwards, providing a major boost to household disposable income. This coupled with the current strength of the labour market, should lead personal spending to grow by 6 per cent in 2006 and by as much as 8 per cent in 2007. Much of this growth will be fuelled by a fall in the personal savings ratio following the ending of the SSIA scheme.
Solid growth is also expected in government spending and in fixed investment. Exports are forecast to improve on their weak performance in 2005, helped by stronger growth in Europe, a more favourable exchange rate and signs of a revival in Irish manufacturing activity in the second half of 2005. Overall, we expect that GDP will rise by 5 per cent in 2006, close to the trend growth rate of the economy.
A notable feature of the economy in 2005 was the strong growth in employment, which is estimated to have increased by around 4.5 per cent. Most forecasters expect a significant slowdown in employment growth in 2006 to 2.2-2.5 per cent. We are more optimistic and see employment rising by close to 3.5 per cent this year. Meanwhile, the unemployment rate is forecast to remain low at around 4.2 per cent.
While there has been some concern expressed about our longer term vulnerability to the rising share of construction sector employment in total employment, other sectors such as financial services and the wholesale and retail trade have also performed well. Construction's share in total employment will undoubtedly fall in due course but, in the short to medium term, the economy needs more and not less construction.
One interpretation of the recent trends in output and employment is that Irish productivity growth has slowed dramatically, potentially limiting future growth in national income. However, it would be a mistake to base a view on national productivity trends on one or two year's figures. As with many other economies, Ireland is moving towards a service economy, which probably means slower growth in overall productivity. However, calculations based on very recent trends are overly negative in this regard. It is important to distinguish between cyclical and structural or trend movements in productivity growth.
Productivity growth is best measured on a trend or multi-year basis. Using this approach, productivity growth for the whole economy averaged 3.8 per cent per annum in the 1995-2000 period. This slowed to 2.3 per cent per annum in the 2000-2005 period. However, excluding the “modern” industrial sectors, annual average productivity growth in the 2000-2005 period slowed to 1.9 per cent from 2.7 per cent in the previous five year period. About half the slowdown in overall productivity, therefore, is due to the weaker trend in the modern sectors. However, slower growth in overall GDP in 2000-2005 relative to the earlier period has also produced a cyclical slowdown in productivity growth. Some of the slowdown may also be due to the growth in the construction sector and in public sector employment. As regards the former, industry sources would not agree that productivity growth is low, notwithstanding the “evidence” thrown up by CSO data.
In its recent Economic Outlook, the OECD argued that the balance of risks to its own 5 per cent GDP growth forecast for the Irish economy in 2006 was tilted to the downside. It identified an abrupt decline in housing activity as the key domestic risk to the favourable outlook for the economy. On the external side, it identified a marked slowdown in the UK economy or a bout of euro appreciation against the dollar as downside risks, especially for Irish exports.
We remain very confident about the outlook for the Irish housing market. Indeed, we have raised our expectations for both the level of output and the likely trend in average house prices in 2006 and 2007. Demand remains very firm in the sector and we now expect house completions to run at about 77,000 per annum until closer to 2008. House price inflation should also stay relatively high at about 7 per cent per annum.
We expect growth in underlying private sector credit of around 28 per cent in 2005 and 22 per cent in 2006.
In our view, the main downside risks for the economy are external. Oil prices and the risk of a disruption to oil supply remain a concern. The continuing imbalances in the US economy are also a cause for concern. There are also some signs of a possible weakening in the US housing market, which could have serious knock-on consequences for the rest of the economy. Any of these factors could trigger a sharp fall in the dollar.
The risk of a very significant fall in the US dollar against other major currencies constitutes the single biggest threat to the Irish and European economies. However, while we envisage some weakness in the dollar this year, its decline against the euro is likely to be limited to below the $1.30 level.
Overall, therefore, the external economic environment looks broadly favourable for the coming year. The domestic economy, meanwhile, looks set for strong growth, with maturing SSIA accounts set to deliver a major boost to activity in 2006 and 2007. Thus, economic growth looks set to strengthen even further this year. |
John Beggs is chief economist at AIB Global Treasury
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