Irish Household debt, Deleveraging and Wealth

Consumer spending in Ireland accounts for around half of GDP and in 2013 probably amounted to some €83bn or €11bn below the peak year of 2008. Consumption is largely driven by  real household income  which has fallen sharply in recent years, but household wealth also plays a role and so the housing collapse has also had an impact, with households deleveraging in order to rebuild net wealth. Annual consumption appears to have fallen again in 2013 but picked up through the year after a very weak first quarter and the  latest retail sales data showed a strong end to the year in term of High street spending, with sales excluding cars rising by 2.8% in volume terms over November  and December. The consensus view sees that upturn translate into a rise in real consumption this year (the Budget is predicated on a 1.8% increase), largely driven by a recovery in household income, and the latest data from the Central Bank is also  potentially supportive in terms of the trend in household wealth although deleveraging is still very much in evidence, adding downside risks.

Household wealth comprises financial assets and housing, with the latter dominating in Ireland. Net wealth (i.e. the value of assets minus debt) peaked at well over €700bn in 2008  and then plunged to less than €450bn largely as a result of the collapse in house prices. Indeed, the net financial worth of the household sector bottomed in late 2009 and has been on a rising trend since, increasing to €148bn in the third quarter of 2013 ( on a 4-quarter moving average, the measure preferred by the Central bank), which is a new high. Around a half of gross financial wealth is in the form of equity reserves in pension  and insurance funds and the recovery in stock markets  has had a big influence as the amount held by households in cash and bank deposits has not greatly changed of late. The pick up in house prices is also significant as it has boosted housing wealth with the result that total net wealth is now some €50bn higher than it was a year ago, rising to €490bn in the third quarter.

The improvement in the net worth position also reflects a significant decline in household debt. That peaked in the final quarter of 2008 at €204bn (total liabilities were and still are around €10bn higher but the Central bank concentrates on loans owed to financial institutions) and has fallen by €35bn since then, to €169bn in the third quarter of 2013. Deleveraging on that scale has also resulted in a fall in the debt burden (debt relative to disposable income) but the decline in the latter has been slower reflecting falls in the denominator, with the latest reading at 196% of income from a peak of 214%, recorded as recently as the second quarter of 2011. The debt ratio is still very high by international standards and  although the rise in net wealth is a positive for the economy and will have some influence on the future pace of deleveraging no one really knows when the latter will come to an end and that adds to the degrees of uncertainty surrounding any consumption forecast.

Dublin House price inflation likely to slow this year

Irish residential property prices fell by 4.5% in 2012 according to the CSO index  and by 2.5% in Dublin, and although most commentators expected the market to pick up a little in 2013 few if any envisaged the pace of price appreciation that developed in the capital; Dublin prices rose by 15.7% last year with apartments outstripping houses, appreciating by 20.8% against 15.3% for the latter. Residential prices  in the capital have still fallen by some 49% from the peak but the strength of the recent rally has prompted some to forecast further double digit gains in 2014. That appears unlikely for a number of reasons.

The case for some further price appreciation nationally and in the capital  can certainly be made. A range of studies since 2012, including work from the Irish Central Bank, the IMF and the OECD, have signaled that Irish house prices probably fell too far in relation to housing fundamentals, such as income and rents. The latter has risen strongly now for a few years ( the latest CSO data for November puts the annual increase in national residential rents at 8.5%) and house prices relative to rents are now well below the long term average. That is the equivalent of stating that the average yield on residential property ( i.e the average rent divided by the current price ) is also well above the longer term trend and on my data base is just shy of 6%, the highest in a decade. Affordability is also a plus for the market; a new 25-year mortgage absorbs 24% of income in 2013 which is well below the 29% long term average on my affordability index and back to levels last seen in 1998. Employment is also rising and  price expectations have also probably shifted, with more people expecting prices to rise and hence helping to bring forward purchases. House building is also at record lows ( averaging around 2,000 a quarter in 2013), albeit bottoming out, and the vacancy rate in parts of the capital is low. There would not appear to be a significant supply shortage in apartments, however, yet apartment prices appreciated faster than house prices  last year both nationally and in Dublin, albeit from a lower base, which implies that supply is not the sole explanation for the trend in prices.The vacancy  rate outside the capital is much higher nonetheless, so in theory at least there is  more excess supply to meet the increase in demand, which helps to explain why prices outside Dublin were broadly flat last year, but having fallen by 6.1% in 2012.

Dublin property price inflation may well decelerate this year,  although still rising at a single digit rate. In part this expectation reflects the nature of the market last year, with  cash transactions  probably accounting for slightly over half the total recorded  by the Property Price register ( the IBF data on mortgage drawdowns is not yet available for the full year) although the proportion funded by credit did rise through the year and may have been around 54% in the final quarter. Ultimately housing is largely driven by credit and mortgage lending may well pick up this year but is still likely to be a a level which is not compatible with further price appreciation at the pace seen last year in Dublin. Repossessions are also on the rise which may dampen price pressures somewhat while the trend in the price  index itself  in 2013 is another factor arguing for deceleration; prices rose by 2.4% in the second quarter, by 9.5% in q3 and 3.9% in the final quarter and so  annual property price inflation in Dublin is likely to slow in the second half of 2014 as those base effects kick in.

Stagnation and relative performance in the euro area

The new year has brought greater optimism in relation to the global economic outlook, with a number of international economic organizations revising up their growth forecasts or indicating that such a move is imminent. Time will tell whether the more upbeat mood is warranted ( the last few years have seen initial forecasts subsequently revised down) and it is noticeable that the ECB remains very cautious on prospects for the euro area, pointing to downside risks, although the Bank is in line with the consensus in expecting a modest upturn, with growth of 1.1% forecast for this year and 1.5% in 2015, following a 0.4% contraction in 2013 and a 0.6% fall the previous year. Those figures refer to the euro area as a whole, of course, and are a weighted average of the constituent countries, and as such can hide significant variations across the zone.

Indeed, the divergence in  relative economic performance since the inception of the euro in 1999 is extraordinary. Eleven countries adopted the single currency at that time (the total has now risen to eighteen following Latvia’s entry at the turn of the year) and some of that initial group has prospered while others have stagnated, as measured by real GDP per capita. According to the IMF’s data on the latter , Finland has been the best performer over that period, with  real income per head rising by 20%, marginally outstripping Germany (19.4%) . Austria is in third position, at 18%, followed by Ireland in fourth, with a cumulative gain of 17.6% despite a sharp decline since 2007. These figures are better than that achieved by the major advanced economies over the same period, led by the UK at over 16% followed by the US around 15%,

The figures cover a fourteen year period and so even the strongest performance, such as  that of Germany, translates into  annual average  growth in GDP per head of 1.25% with the majority of the original eleven euro members not achieving 1% per annum. France is notable in that regard, with average growth per head of only 0.6% and a cumulative increase of just 8.7%, putting it in eighth position. That is only marginally better than the that of Spain, which is often portrayed as a chronically poor performer. Portugal is viewed through a similar lens but the data is still surprising, showing zero growth in Portuguese real income  per head since 1999. Yet that dismal statistic is dwarfed by the figures for Italy, as real GDP per capita is actually 3.5% lower now than it was at the birth of the single currency.

Economic growth in the medium to long run is the product of growth in the labour force  and the capital stock alongside technological progress so this pronounced divergence in performance could be put down to  respective differences in these ‘real’ factors  and not to the single currency per se- hence the emphasis from the ECB and the European Commission on ‘structural’ reforms in the euro area, which one takes to mean measures to boost the supply side of the economy and potential growth. Yet it is also undeniable that some countries have found it very difficult to cope within a monetary union dominated by a super-efficient industrial powerhouse and it is remarkable  that the electorates in those economies  have apparently learned to live with that stagnation.

Press Conferences, the ECB and the Fed

The ECB and the Fed differ at many levels, including their respective mandates (the latter is charged with  maintaining full employment as well as price stability ) and the frequency of policy-setting meetings (one a month for the ECB but only eight a year for its US counterpart). The Fed’s Open Market Committee, which sets monetary policy, has twelve voting members and releases minutes of its deliberations, including the voting pattern, whereas the ECB Governing Council’s  membership is double that, with no published minutes, at least to date. They do have one thing in common though- press conferences hosted by the Head of the institution- although the Fed has only recently adopted that practice and limits it to one a quarter, as against the ECB’s regular slot on the first Thursday of the month.

The press conferences also differ markedly however. Ben Bernanke has held court at all of the Fed’s to date, and things may change when Janet Yellen takes over, but  there is a much more open  atmosphere than in Frankfurt and it probably reflects more than the personalities involved. This may in part be due to the nature of the audience, which is smaller in number than for the ECB and made up largely of ‘Fed-watchers’, who like the Kremlinologists of old are attentive to the slightest hint of any change in policy. Few, if any, foreign journalists appear to be present and the questions are usually to the point and illicit equally straightforward responses from the Chairman. One senses that there is an implicit belief that the population have a right to know what the Fed is thinking and the questioners seek to tease out any areas where there is a lack of clarity, although of course central bankers are not omniscient and any statement of intent is always contingent on events.

The ECB conference is more formulaic ( the President opens by reading a much longer statement than that issued by the Fed ) and the atmosphere feels very different, at last as viewed on television,  with the ECB President often striking a defensive and sometimes peevish tone, with attempts to justify past policy decisions (‘ the events of the past month have vindicated our  stance’). One is always left with the impression of an audience seeking to illicit answers from a Bank reluctant to elaborate,  which leaves an unsatisfied taste. A good case in point is OMT, which is regularly raised and is met with the response that all has been explained at some earlier meeting  although if that were the case the question would not arise. The sheer numbers involved in setting ECB rates inevitably makes for differing views in the Council and that may explain the President’s  caution in response to some questions but at times the dichotomy between the Bank’s  current stance  and its stated policy aims is glaring; the ECB is  forecasting inflation in 2015 at 1.3%, for example, which does not appear consistent with its definition of price stability (‘below but close to 2%’) and implies monetary policy is too tight, even after the recent rate reduction.

Monetary policy in the euro area is  certainly more pragmatic under Draghi and the ECB has moved a long way from its Bundesbank-centred roots. The  press conference has  also ditched some of  the rituals common in President Trichet’s time, when everyone listened for some key words, like ‘strongly vigilant’, as a signaling mechanism- what’s wrong with saying  that ‘ we are likely to raise rates at the next meeting in the absence of unforeseen events’ rather than use some code?. The questions  also vary in quality and relevance it also has to be said, with some journalists seeking comments on specific country issues which are beyond the remit of the ECB (‘Draghi praises Ireland’s/ Portugal’s/ Italy’s/  stoic adherence to fiscal rectitude’). One final point. President Draghi’s pledge ‘to do whatever it takes to preserve the euro’ was queried by a (German) journalist at one press conference, with the latter pointing out that Governments and ultimately electorates would decide the single currency’s fate. An unusual intervention , highlighting that the ECB is ultimately accountable to the citizens of the  euro area, and that it is their Central Bank.


Tax Take in December implies weak consumer spending

The  Irish Exchequer returns to end-December showed tax receipts for the full year at €37.8bn which is in line with the revised estimate published by the Department of Finance in mid-October. This represents a 3.2% increase on 2012 although still €150mn adrift of the original Budget projection, which was predicated on stronger economic growth than eventually emerged. The last month of the year often throws up surprises and so the authorities will no doubt be relieved that the (revised) target was met although that satisfaction may also be tinged with some disappointment following a very buoyant tax intake in November, which opened the prospect of a strong end to the year for the Exchequer. In the event December proved a very weak month in terms of receipts, with tax revenue coming in €360mn behind profile, or 12%, with all the main headings  adrift, including a very large shortfall in VAT, which came in at €89mn instead of the projected €211mn. The implication is that Irish consumers did not spend as freely as some expected in December, at least before the post-Christmas sales.

Non-tax current receipts were stronger than expected, however, ending the year at €2.7bn against an original forecast of €2.4bn (thanks in the main to the ELG scheme and increased dividends) so total current receipts ended the year at €40.5bn or €200mn ahead of the Budget projection. Voted spending came in 0.4% below profile for 2013 as a whole although again that masks a very strong spending round in December, particularly on the capital side, as the undershoot was over 2% at the end of November. Total current spending actually rose over the full year, by 1.6%, but this reflects higher debt costs and masks a sharp (4%) fall in day to day expenditure.

The combination of revenue growth and spending restraint has led to a steady fall in Ireland’s fiscal deficit although 2013 still saw a Current Budget shortfall of €10.6bn. The capital Budget was boosted by the State’s decision to sell various financial investments in Bank of Ireland and Irish Life with the result that the Capital deficit was  around €5bn smaller than originally envisaged, at €870mn. The overall Exchequer deficit came in at €11.5bn against an original target of €15.4bn and broadly in line with the revised projection of €11.3bn made a few months ago.

On the funding side the authorities drew down the last of the monies available from the Troika , raised some €2bn from State savings products, and used the proceeds from bond issuance early in 2013 to buy back some of the bonds due for redemption this month. That transaction meant that net funding broadly matched the Exchequer deficit leaving cash balances at the end of 2013 at €23.6bn and as such largely unchanged from the previous year. This cash pile is expensive to hold ( given short term yields are virtually zero) but means that the authorities do not have to fund this year unless they want to, but will have to weigh the costs of increasing those balances against the benefit of  returning to the bond market in the near term.