Irish Economy soaring, now well above pre-crash peak

The CSO has just published the Irish National Accounts for the first quarter, incorporating data revisions and an adjustment for aircraft leasing, with gross aircraft flows now  included as against a net figure. In the event the  combined impact was substantial, with upward revisions to all GDP components, leaving nominal GDP in 2014 at €189bn compared with the previous estimate of €185bn. In real terms the recession in 2008-09 is now seen to have been milder, albeit a still bleak 9.8% fall in GDP over 8 consecutive quarters, with the recovery stronger; the  new data  shows the  economy to have grown in every one of the past five years, with the 2014 initial estimate of 4.8% now put at 5.2%. As a result  it now appears that all the output lost in the crash was recovered by the third quarter of 2014  and real GDP is  currently 3.8% above the previous peak recorded in the final quarter of 2007.

The pattern of the recovery as previously understood remains broadly intact, with a positive impact from external trade offsetting falling domestic demand, although the latter is now seen to have grown in 2012 , driven by investment spending, before declining again in the following year. Consumer spending  of late is now  stronger than previously recorded , which is more consistent with retail sales , while GDP as a whole is now better aligned  with the recovery in employment, which started in early 2013.

The recovery picked up strong momentum in 2014, with  all the 5.2% expansion in real GDP driven by domestic demand, led by double digit growth in business spending on machinery and equipment alongside a 10% rise in construction. Consumer spending also grew , by 2%, although the reported 4.6% rise in Government spending is more difficult to fathom, and appears to be related to  the productivity gains assumed to flow from the Haddington Road agreement with public sector unions

The previously published data had shown a marked slowdown in the second half of last year but that has now been revised away, with the result that the economy entered 2015 in a stronger position than initially thought. Moreover, growth in Q1 was also robust, at 1.4%, leaving the annual change in real GDP at 6.5%. Consumer spending is now rising strongly in volume terms, by an annual 3.8% , although the annual growth in investment spending slowed to 4%, albeit dampened by the volatile aircraft sector.

Net exports also made a strong contribution to the annual growth figure in q1, adding 2.1 percentage points, with the  figures now reflecting aircraft leasing as well as last year’s methodological changes. Exports grew by an annual 21% in value terms ,and by 14.3% in volume terms, with the latter marginally lagging import growth of 14.7%, although such is the scale of exports that a similar growth figure in imports still generates a strong net contribution from the external sector.

The external data has also confounded the many looking for much smaller  gains in 2015, and that, alongside the GDP figure itself,  will likely prompt upward revisions to growth  forecasts for 2015 as a whole. The nominal rise in GDP in q1 was also surprising (an annual 12%, largely reflecting a big increase in export prices)  and estimates for nominal GDP  growth  this year may well be raised to at least 10%. The latter would mean a 2015 figure of €208bn, implying a debt ratio around 102% and a fiscal deficit under 2% of GDP. Good news then, but one  final implication: the Central Bank, IFAC and the ESRI have already urged the government to reduce the size of the proposed fiscal stimulus  in the 2016 Budget and the figures published today strengthen their case, it would seem, although one doubts if that  will cut much ice with the governnment ahead of the election.

 

Irish Housing Supply points to further pressure on Rents and Prices

The supply of new housing responds to changes in price with a time lag, which can lead to periods of excess building and , as in Ireland of late, a chronic  excess demand for residential property, particularly in areas where people want to live. Housing completions  did rise significantly in percentage terms last year, by 33%, but such was the collapse in house building in the period 2007-13 that the recovery  in 2014 left  actual completions at  11k.This added just  0.5% to the existing housing stock (around 2 million) and  as such is  below the depreciation rate. Moreover, it compares with a figure of   25k that has become the consensus view on the  annual supply required over the next 5-10 years.

House prices rose by 22% in Dublin last year and by over 10% elsewhere in Ireland which  indicates  a clear price signal. Completions in the first quarter of 2015 amounted to 2.6k , representing a 26% annual rise, but the pace of growth slowed sharply in q2, to 9%, with  a supply figure of 3k. So completions over the first half of the year came to  just 5.6k and our model now indicates an annual figure of less that 13k. The official completions data is based on connections to the electricity grid so  the total can also include properties previously partially or largely completed as well as new builds, which adds a further uncertainty to any annual forecast.

Housing demand projections tend to put the figure for Dublin (city and county) at  around 30% of the national total, implying an annual supply requirement of 7k-8k. That ratio was met last year although the actual supply in Dublin was only 3.3k, no doubt also augmented by previously unfinished developments.  Still some way to go then to match forecast demand, particularly as  the Dublin figure in the first half of this year was only 1.4k , less than a quarter of the national total, with apartments accounting for 0.5k of completions in the capital.

In our previous Blog ( ‘Irish Mortgage Regulations impacting the housing market’) we concluded that the new LTV limits were affecting mortgage lending and housing transactions but were not having a dramatic impact on prices. There is also evidence that the pace of rental growth is accelerating and the implication is that only a sustained  and substantial increase in supply will bring the housing market into broad balance. The latest completions data suggests that will take some time.

Irish Mortgage Regulations impacting housing market

In late January the Irish Central Bank announced a set of macro-prudential controls on mortgage lending, Similar regulations have been introduced elsewhere, in line with the new orthodoxy in central banking, which  seeks measures to influence credit growth outside the traditional interest rate channel, particularly as rates are currently at historically low levels. The Irish version imposed a loan to value limit of 3.5 on Personal Dwelling Home (PDH) mortgages, but in the current Irish context the  second limit, on Loan to Value (LTV) was seen as a more binding constraint. A  maximum LTV of 80% is now in operation on PDH  mortgage loans, with first time buyers allowed 90% on properties up to €220k. Banks are allowed some discretion , but it is limited in that only 15% of loans can exceed these LTV ceilings.

Contrary to some commentary (and expectation), the controls were not seen as having a material impact on prices, and the Central Bank’s research showed that the  main effects would be on mortgage lending and the supply of new housing. Of course the controls would be pointless absent some effect on credit creation and in the Bank’s base case lending falls by 9% on the introduction of the new regulations and subsequently recovers some ground, although remaining below the benchmark case ( i.e. absent any controls) for over seven years.  In simple terms the new rules will require prospective buyers to save for longer, which also implies greater pressure on the rental market for any given level of housing demand.

Six months in, there is some evidence that the measures are having an impact across the housing market. Mortgage credit standards tightened appreciably in the first quarter and the latest Central Bank data shows that mortgage demand eased considerably in q2, from very buoyant levels over the past year.  That change is also evident in terms of mortgage approvals, with the annual increase slowing sharply in the three months to May, to 17%, from 41% in q1 and 56% in the final quarter of 2014 ( the latter  was probably affected by expectations ). Indeed, the annual rise in approvals in May alone was less than 8% and our own  mortgage models points to drawdowns for house purchase of 5.2k in q2, unchanged from the previous quarter.  New mortgage lending is still growing strongly on an annual basis but at a much slower pace.

Turnover in the housing market , which picked up very sharply in 2014, also appears to be slowing, based on data from the Property Price Register. Transactions amounted to 10.5k in the first quarter of 2015 and  also exceeded  10k in q2, but the annual rate of growth slowed to 13% from over 55%. The June figure was actually 7% down on the previous year and although late additions to the  Register are common the broad picture is unlikely to be seriously altered.

What about prices?  An unusual feature of the current upturn in residential values is the relatively high share of transactions (over 50%) driven by cash and so it would be surprising if the mortgage controls did have a very significant impact in that area. Dublin prices did fall in the first three months of the year, by 1.6%, but rose by 2% in q2, with a similar pattern evident in the rest of the country (a 2% rise following a 0.3% fall). The market has certainly cooled relative to the first half of 2014, but smaller price gains rather than outright falls appears to be the order of the day.

What about private sector rents?  Here, data from the CSO does point to an acceleration in what was already a buoyant market; rents rose by 1.7% in the three months to December but then picked up by 3% in the first quarter of 2015, followed by a 2.4% advance in q2. That means rents nationally are only 2% below the all-time highs recorded in 2008 and are therefore likely to surpass that figure by the final quarter of 2015.  As for housing supply it is too early to tell. although with only 2,600 completions in q1 the base figure is already very low by historical standards.

The central bank model predictions are therefore panning out in broad terms; mortgage demand has slowed, approvals have eased and transactions have  been affected , although  the impact on prices has not been dramatic.  In addition, the  upward trend in rents shows no signs of abating and that  perhaps  best illustrates  the real issue in the market- the shortage  of housing supply in the areas people want to live.

Grexit now more likely after latest Eurozone ‘deal’

The Eurozone has announced  what the headlines refer to as a ‘deal’ on Greece , emerging  from yet another all-night negotiating session. History suggests that agreements reached in the wee small hours by sleep deprived participants can look very different to at least some  bleary eyed negotiators in the clear light of day, but that aside the agreement is  quite extraordinary, and breaks new ground in terms of euro zone governance. Indeed, such is the departure from previous discussions with debtors that, if anything, it increases the risks of Greece leaving the euro.

The text of the Euro Summit on Greece opens with a statement on  the need to rebuild trust with the Greek authorities and to that  end  Athens has to pass legislation, by Wednesday 15 July, on a range of measures, including pension reform , changes to the VAT system, the independence of  the state statistical service and the setting up of a Fiscal Council. In addition the legislation should include ‘quasi-automatic spending cuts in case of deviations from ambitious primary surplus targets’ and by the following week new laws  changing the civil justice system. The ECB will maintain the existing level of ELA for a little longer, to focus Greek minds, while the banks will remain shut.

Upon a satisfactory conclusion of the above, and subject to the approval of ESM member states, negotiations may start on a new loan, but Greece has also to set out a timetable for the implementation of  another raft of reforms, including further changes to the pensions system and  significant moves to liberalize retail markets , the professions, labour markets and the financial system. The energy transmission mechanism is also to be privatized, and in that context the text also proposes  an unprecedented step, in that Greek assets are to be sequestered into a separate fund for privatization, with the intention of raising €50bn, to be used to finance the recapitalization of the banks, to run down debt and to fund investment.  Moreover, Greece also has to undo some of the legislation brought in by the new Administration  and is required to ‘consult and agree with the Institutions on all relevant areas before submitting it for public consultations or to parliament’

The Hellenic Republic will also have to seek a further IMF loan and a total bailout figure of €82bn to €86bn is envisaged, although the text also notes that fulfilling the initial conditions does not guarantee that a  loan will follow. The Eurogroup may consider debt extensions and changes to interest rates but ‘ nominal haircuts on the debt cannot be undertaken.’

Some might consider all of this a move to shift Greece towards a Northern European style market economy and one consistent with euro membership  while others have already branded it as a ‘coup’, with the Eurogroup  accused of seeking regime change . The degree of interference and control from Brussels is certainly a new departure as is the idea of preconditions before negotiations can even begin. The latter certainly increases the risk that political support in Greece will not materialise, particularly as the electorate have already rejected a less severe version of the measures now mandated. In addition, implementing reforms, even if passed by parliament, may prove extremely difficult , if not impossible.  A debt write down is also not on offer, even though many, including the IMF, see the debt situation as effectively unsustainable.

Perhaps the most striking development over the weekend was the German proposal that Greece could take a 5-year timeout from the euro area. Leaving aside the practicality of such a move the fact that it was put into the open ( although not in the final text)  shows that Grexit is no longer seen by some creditors as a disaster, Indeed, the ‘take it or leave it ‘ tone  of the offer is also striking (‘the risks of not concluding swiftly the negotiations remain firmly with Greece’) and one can only conclude that the probability of a Greek exit from the eurozone has increased, either  through a Greek rejection of the proposals or via some creditors still  baulking at what they see as the futility of throwing good money after bad.

When Debtor Fatigue meets Creditor Fatigue

The euro has always been a politically driven project, and the inevitable economic fault lines that emerged  as it expanded  have been met with a surprisingly strong will on the part of  member governments to maintain the single currency. That determination has surprised markets and often confounded analysts , although  any decisive political action has often emerged from crisis meetings in the early hours of the morning. Decision making in such an environment raises issues of democratic accountability and  risks serious policy errors ( for example the determination to prevent a sovereign default within the EA) and  post-meeting disagreements on what was actually signed off ( see Ireland’s belief that the ESM would be able to retrospectively recapitalize banks). The euro is also now left with fiscal rules  and constraints which are  both extraordinarily complex and lacking in credibility; no one believes that a euro member will be fined for a breach and the Commission has repeatedly backed down when faced with one of the larger member states, notably France .

In the absence of a fiscal union the euro member states have funded bailouts for sovereigns who have lost market access, first directly (as per the first Greek loan) and then through the EFSF. Initially the loans carried relatively high interest rates ( as a form of punishment for fiscal impropriety) but that soon changed as debt sustainability came to the fore, an issue of particular importance to the IMF, which was brought on board  to help design loan programmes and the incorporated conditions.

The Fund’s modus operandi is to  project what it considers to be a sustainable medium term debt ratio  and then derive the required primary fiscal surplus needed to get to that target, given other assumptions including economic growth. Those assumptions can prove spectatularly wrong , and they did in Greece ; the  negative impact on the economy of the required fiscal contraction was much greater than envisaged (  GDP fell 25%, a depression rather than a short lived recession) and  the  forecast €50bn receipts from privatization failed the matrialise ( the figure to date is around €3bn).

Such programmes also assume that creditor governments can deliver the required primary surpluses, however large and sustained they are deemed to be , and ignores the electorates role. Debtor fatigue can set in. In most  countries that has been confined to  (growing) opposition parties but in Greece resulted in a new government pledging an end to austerity, new loans, a debt write down and ongoing euro membership,

Much of that is not in the gift of the Greek authorities to deliver (who knows what electorates can decide )  and that debtor fatigue is now meeting creditor fatigue, which has not been eased by the unusual negotiating stance adopted by the Hellenic Republic, which some characterise as driven by game-theory and others see as inconsistent and bordering on farce. The creditors are not united, it has to be said, with France notably sympathetic to Greek requests, although most , to date at least, appear willing to see Greece exit the euro, such is the lack of faith in Greece’s ability to deliver reforms or to meet the terms of any new loan. Some of that hostility emanates from other debtor countries fearful of the impact of a perceived Greek success on their own political futures- we are all creditors now, it would seem.

Any new money, should it materialise,  will come from the ESM, and that requires a unanimous decision by the Board of Governors, made up of member states. Consequently  any one country can prevent disbursement. In addition, ESM debtors are required to be in a programme which it is envisaged would involve the IMF, so Greece’s default with the fund poses a difficulty.

The Greek crisis has also highlighted the Lender of Last Resort issue . The ECB is not willing to fulfill that role unconditionally and has limited the amount of emergency liquidity the Central Bank of Greece can provide to its banking system. So the ECB, despite its claims to the contrary, emerges as a key player; its actions put pressure on the Greek government to reach an agreement with the creditors and could be the  catalysts for  Grexit, as the pulling of ELA would require Greece to print its own notes to fund the economy.

The markets have shown little in the way of panic reaction to  the Greek saga  and probably feel that some compromise will emerge to keep Greece in the euro, if only because such last-minute deals have been the norm in recent years. Whatever the outcome the stark emergence of debtor and creditor fatigue into the light is a profound  development , and one which is likely to have significant longer term implications for the euro regardless of any short-term fix.