| | | | | | | | | | | | | | | INTERNATIONAL ECONOMIC BACKGROUND
There has been considerable comment in recent months about apparent ‘green shots of recovery’ in the global economy. This type of commentary has reasonably solid foundations. Most recent available evidence is suggesting that the downward momentum in the global economy has been arrested and that stabilisation is now occurring.
In the US, most housing indicators are looking somewhat stronger. Building permits increased by a stronger than expected 518,000 in May, but that still represents a decline of 47% on a year earlier. The Case-Shiller 20-city house price index shows that prices fell by 18.7% in the year to March 2009, but there are some suggestions that the rate of decline is decelerating. Consumer confidence has jumped from a record low reading of 25.3 in February to 54.9 in May and the purchasing managers’ index for manufacturing activity has jumped to 42.8 in May from a low of 32.9 in December 2008. The index for service sector activity has jumped to 44 from a low of 37.4 last November. A reading below 50 signifies that activity is contracting, but the rate of contraction is clearly starting to decelerate. However, the stabilisation is happening at a very low level of activity, as reflected by a US unemployment rate of 9.4% in May and total employment in the economy has fallen by 6 million since the beginning of 2008. In the first quarter, US GDP contracted by a massive 5.7%.
Recent data in the US showed that a staggering $1.3 trillion (€0.93 trillion) has been wiped off the personal wealth of Americans and the level of net personal wealth is now back at the levels of 2004. Net personal wealth in the US is defined as the difference between the value of assets such as homes, bank accounts and investments on one side of the balance sheet, and liabilities such as mortgages and all other types of debt on the other. This level of personal wealth destruction is huge and is one structural reason why the US economy is unlikely to suddenly bounce back from the current deep recession. Consumers will be more interested in paying down debt and building up savings again before they get back into the business of spending money. In other words the US personal sector will want to repair its balance sheet before normal business resumes. That could take some time.
In the Euro Zone the economic stabilisation story is similar. The purchasing managers’ index for manufacturing jumped to 40.5 in May from 33.9 in March, and the service sector index jumped to 44.8 in May from a low of 39.2 in February. Like in the US, the stabilisation is happening at a very low level of activity. The Euro Zone unemployment rate jumped to 9.2% in April, which is the highest rate since September 2009. Unemployment in the zone increased by 396,000 in April and has increased by 3.2 million over the past year. GDP in the Euro Zone recorded a record decline of 2.5% during the first quarter, and was 4.8% lower than a year earlier.
The largest economy in the Euro Zone, Germany, contracted by 6.9% in the first quarter of 2009. However, the weakness is primarily due to the collapse in external demand which has seriously undermined the German export performance. As external demand conditions gradually improve over the coming year, the German export performance should improve given the competitiveness of the German economy. The influential German Ifo survey of business confidence jumped to 85.9 in June, which is up from a cycle low of 82.2 in March. Confidence is still at low levels, but the trend is now starting to improve. There is still a long way to go, however.
In the UK, the story is also quite similar. The purchasing managers’ index of manufacturing activity jumped to 45.4 in May, up from a low of 34.5 in November 2008. The purchasing managers’ index of service sector activity jumped to 51.7 in May, signifying expansion in that sector. It reached a low of 40.1 in November 2008. The UK economy contracted by 4.1% in the first quarter of 2009.
Despite the justified improvement in optimism based on a stabilisation of economic activity almost everywhere across the global economy, it is important to bear in mind that this stabilisation is occurring at exceptionally low levels of activity. This stabilisation is due to the very strong official policy response to the exceptional difficulties that have befallen the global economy over the past 18 months. Interest rates have been slashed to historic lows, fiscal policy is being expanded where possible, and bank re-capitalisation efforts are continuing around the global financial system.
The recovery process is likely to build gradually from here. However, given the nature of the shock to the global financial system and the damage that has been done to the global corporate sector, and the massive destruction of personal wealth that has occurred in economies such as the US, UK and Ireland, the recovery process is likely to be slow and gradual, rather than v-shaped. |
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| | | | INTEREST RATES
Global interest rate conditions have stabilised. There is no pressure on any of the major central banks to adjust interest rate policy in either direction for the foreseeable future. Growth is still weak and inflation is very subdued and this looks set to remain the case for the foreseeable future.
However, the strong likelihood is that we are at the bottom of the interest rate cycle and the next official move in rates is more likely to be up rather than down. With the strong monetary stimulus now occurring around the global system, central bankers will at some stage start to worry that strong money supply expansion will eventually result in increased price pressures. However that is unlikely to happen in 2009, but some modest tightening of interest rate policy could be seen in 2010, provided the global economic cycle gradually improves, which is likely to be the case. At this early stage it is possible that the ECB could double official rates from 1% to 2% by the end of 2010. Thereafter rates could gradually edge up towards 4.25% by 2012.
Central bankers will have to be aware of the policy mistakes made in the 1930s when monetary and fiscal policies were tightened too soon and created a double-dip recession.
The shape of the Irish yield curve has normalised in recent months. However, the 5-year rate at 4.14% is still 152 basis points higher than Germany. Given that Ireland is in a monetary union with Germany, this differential is very high and is indicative of the deteriorating risk profile of Ireland as a result of the rapid deterioration in the public finances and the problems in the financial system. However, the interest rate spread has narrowed in recent months as markets become somewhat more relaxed about the fiscal correction plan in place. Given the fiscal mess in Ireland it is not clear that this optimism is justified. However, investors recognise that Ireland will never be allowed default on its debt and that the ECB would actually have no choice other than to purchase Irish government bonds in order to preserve the stability of the single currency area |
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| | | | THE IRISH ECONOMY
The Irish economy is currently in the midst of extremely challenging economic and financial circumstances. Economic growth is contracting sharply, unemployment is rising sharply, and the public finances are deteriorating at a rapid pace as the sharp slowdown in economic activity is putting significant downward pressure on tax revenues and upward pressure on government spending.
For 2008 as a whole, GDP fell by 3% and GNP by 2.8%. In the first quarter of 2009 GDP contracted by 8.5% and GNP by 12%, representing the biggest ever decline in Irish growth. This slowdown in activity over such a short period of time is quite dramatic and has come as quite a shock to the economic and political life of Ireland.
While growth data are only available for the first quarter of 2009, it is clear from all available indicators that activity levels are very weak: | | |  | The volume of retail sales in the first four months of 2009 was 20.6% lower than the first four months of 2008. This slowdown in retail spending reflects the pressure on disposable incomes from falling employment, nominal wage cuts in many sectors of the economy, and the increased personal tax burden inherent in the Government’s fiscal consolidation strategy. In addition there has been considerable destruction of personal wealth over the past couple of years. The key weakness in retail sales is concentrated on the auto sector. Excluding the motor trade, retail sales were 7.3% lower in the first four months of 2009 compared to the same period in 2008;
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| | Figures released by the Central Statistics Office (CSO) show that the net financial assets of the household and non-profit institutions sector fell by €36 billion during 2008 to reach €81.2 billion. Over the two years 2007 and 2008 the decline has been €58.7 billion, representing a decline of 42% since the highest level of net assets worth €139.9 billion at the end of 2006. Net financial assets is the difference between deposits, shares, life insurance and pension fund assets on one side of the balance sheet, and mainly loans on the other side. The key contributory factor to this decline in wealth during 2008 was the sharp decline in share prices, pension funds and insurance. A point worth noting is that the value of housing wealth is not included in this calculation. Given that the value of the housing stock has probably fallen by close to 45% over the past couple of years, the real situation for the Irish personal sector is considerably worse than the statistics suggest. But at least assets are still exceeding liabilities; |
| | The number of people signing on the live register increased to 413,500 on a seasonally adjusted basis in June 2009. This represents an increase of 252,000 since the middle of 2007. The unemployment rate has jumped from 4.6% in the middle of 2007 to 11.9% in June 2009;
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| | The value of merchandise exports in the first four months of 2009 was up by 2.8%, while the value of merchandise imports declined by 21.5%. The external environment is challenging for Irish exporters, while the sharp fall in the demand for imports primarily reflects the weakness of consumer demand;
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| | Manufacturing output in the first four months of the year was 1.4% lower than the first four months of 2008. Output from the ‘modern sector’ was up by 3.8%, while output from the ‘traditional sector’ was down by 14.8%; |
| | The exchequer returns for the first six months of 2009 show a deficit of €14.7 billion. This compares to a deficit of €5.6 billion for the same period last year. This almost three fold increase in the size of the deficit is indicative of an economy that has weakened sharply over the past year Tax revenues are running 17.3% behind the first six months of last year. Stamp duties are running 64.2% behind last year, which in itself was well behind the previous year. This reflects the collapse in housing transactions. VAT receipts were down by 21.3%, reflecting weak consumer spending and the collapse in new house building. Income tax receipts are running 8.3% behind last year. This is despite the various levies that have been introduced in the two budgets since last October. Corporation tax is 31.4% ahead of last year. This reflects changes in the timing of corporation tax payments announced in last October’s budget, and if this is factored in, receipts are 20% behind last year. Finally capital gains tax receipts are running almost 68% behind last year, which is no surprise given that very few capital gains have been made over the past couple of years; |
| | In the first four months of 2009, the number of Irish people travelling overseas was 10.5% lower than the same period in 2008, while the number of overseas trips to Ireland was down by 6.3%;
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| | On the back of weaker demand in the economy and the sharp fall in mortgage interest rates, consumer price inflation has declined rapidly since the beginning of the year. The headline rate of inflation in June showed an annual decline of 5.4%. Excluding mortgage rates, prices declined by 1.6% in the year to June;
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| | Latest CSO data for the first quarter of 2009 show that employment fell by 89,000 during the quarter, and fell by 158,500 compared to the same quarter in 2008. Over the 12-month period the private sector shed 173,800 jobs, while the public sector created 15,300 jobs. |
| | | All available evidence continues to suggest that the economic momentum in Ireland in the first half of 2009 has remained very weak. For 2009 as a whole, GDP is likely to contract by around 8.5% and GNP by around 8.9%. This would represent the sharpest correction in Irish economic activity since records began.
Prospects for recovery in 2010 will be heavily contingent on an international economic recovery and a restoration of some level of competitiveness in the Irish economy. The international evidence is suggesting that the downward momentum in the international economy is currently bottoming out. It is highly unlikely that there will be a sudden sharp recovery in international economic activity over the coming months given the economic and financial imbalances that still exist in the global economy, the ongoing difficulties with credit availability as a result of banking difficulties, the heavy financial losses that have been suffered as a result of the sub-prime crisis, and the massive destruction of personal wealth that has been experienced around the global economy over the past couple of years.
It will take time to sort these difficulties out and so the global recovery process is likely to be gradual over the next 18 months.
From Ireland’s perspective, any recovery in the external environment will represent good news, but it is clear that Ireland has its own unique difficulties which suggest that the Irish economic recovery will lag the international cycle.
The key issues for Ireland include: | | | | The negative fallout from the housing adjustment is ongoing and is very painful. Jobs are still being lost in construction related activities, house building is still weakening, property related tax revenues are still under significant pressure and house prices are still falling. Quite simply, Ireland is experiencing the largest housing market adjustment in the developed world. It has further to run;
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| | The banking system is still in a very uncertain place despite efforts at re-capitalisation. The banking sector’s balance sheet is seriously damaged as a result of non-performing loans and hence credit availability in the economy is still seriously constrained. It will take some take some considerable period of time to sort out the very difficult banking situation and get credit flowing again. This will act as an ongoing constraint on growth. I theory NAMA is a reasonably good idea, but there is still too much detail to be provided before it can be possible to conclude that it will sort out the problems in the banking sector and get credit flowing again in the economy; |
| | In an effort to address the massive deficit in the public finances, Government is engaging in limited cutbacks in spending and significant increases in the personal tax burden. Pursuing such a tight fiscal policy, with the emphasis on tax increases, in the midst of the deepest recession in Irish history is dangerous and could exacerbate the downturn;
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| | Over the past decade the Irish economy has lost considerable competitiveness. Wage costs, energy costs, professional fees, local authority charges, commercial rates, and IT costs have all increased at a faster pace than our main trading partners. Quite simply, the cost of doing business in Ireland was allowed spiral out of control and there is now a very strong imperative to bring the cost base of the economy down sharply in order to restore domestic and external competitiveness; |
| | Ireland as a location for Foreign Direct Investment (FDI) has become less attractive in recent years as a result of the escalation of costs. At the same time the forces of economic globalization are intensifying, with the emergence of many low cost economies offering skilled labour forces, attractive corporation tax rates and a competitive cost base. The 12.5% corporation tax rate is still an important factor for Ireland but it could be described as a necessary but not sufficient condition for Ireland’s future success in the FDI arena. FDI is unlikely to be as big a driver of the Irish economy over the coming years as it has been over the past couple of decades and indeed holding on to the current levels of FDI will be a significant challenge in itself.
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| | | Against this background, it does appear that following a contraction of 8.5% in the economy in 2009, at this early stage a further contraction of around 1% looks probable in 2010, before the economy returns to a positive growth path in 2011.
| | | | Average | 2008
| 2009f
| 2010f
| GDP
| -2.3%
| -8.5%
| -1.2%
| GNP
| -3.1%
| -.8.9%
| -2.0%
| Consumption
| -0.8%
| -8.0%
| -3.0%
| Investment
| -19.9%
| -30.0%
| -11.0%
| Government
| 2.1%
| 0.0%
| 0.0%
| Exports
| -0.4%
| 1.0%
| 1.5%
| Imports
| -4.4%
| -5.5%
| -2.5
| Consumer Price Inflation
| 4.5%
| -4.5%
| 1.0%
| Unemployment (average)
| 6.4%
| 14.0%
| 15.0%
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