Mortgage market sags and Dublin price inflation slows

It is now nine months since the Central Bank introduced limits on mortgage lending, designed to prevent the re-emergence of another housing bubble. Controls on Loan to Value and Loan to Income ratios make sense , in our view, but not in an environment where net mortgage lending has been contracting for over six years and where the supply of new housing is running far below estimates of medium term demand. The Bank’s research on the topic concluded that the policy would dampen credit growth , have a limited impact on prices and a negative effect on housing supply and that indeed appears to be the case. An unintended consequence is that the pressure on rented accommodation has grown, pushing private sector rents  to an all -time high. It would be foolish to blame the Central Bank for  all the rental growth  but if there is excess demand for housing it will emerge in either house prices or rents  and measures to put a lid on the former will merely spill over to  the latter.

According to the CSO, residential rents rose by an annual 10.3% in the third quarter and the increase in the three months to September was 3.2% so pressure is clearly upwards. The CSO figure is national  and the data on  Daft.ie, which broadly tracks  that of the CSO, shows that rents are rising faster in the Capital, with a 10% annual increase in Dublin City in q2, against an 8.6% figure nationally.

Calls for rent controls in Dublin have been heard (and indeed are not uncommon in cities elsewhere, including New York) but that would be equivalent to dealing with the symptom rather than the underlying cause. The demand for housing is growing, reflecting rising employment, a resumption of growth in disposable incomes, and a sharp fall in net emigration(in fact migration may be turning positive again) with an annual requirement of some 25k seen as a reasonable estimate, including up to 8k in the Capital. On the supply side the collapse in completions bottomed out in 2013, at 8.3k and 2014 saw a pick up, to 11k. Over the first nine months of this year the national figure was 8.9k, including just over 2k in Dublin (city and county) , consistent in our view with an annual total of around 3.2k in Dublin and under 13k for the whole country.

The low base of completions means that modest absolute levels of house building still translate into impressive percentage gains and that is the case with  gross mortgage lending for house purchase, with the number of loans rising by 50% last year. The pace of growth has slowed this year, to 29% in the second quarter, following a tightening of credit standards, and the latest approvals data shows a very rapid change in trend; approvals in the three months to August  were just  1.1% above the same period in 2014 while the figure for August alone was  4% down on the previous year. The average new mortgage , at €191k, is also virtually unchanged on a year earlier and our earlier estimate of 23k new mortgage loans in 2015  and lending of €4.3bn may be too high.

One would expect the Central Bank’s controls to have a bigger impact  on credit and  house prices in Dublin  than elsewhere, given the large price differential in favour of the capital. That does seem to the case; Dublin prices rose by over 22% last year, more than double the pace in the rest of the country, but this year has seen a marked deceleration, with the annual increase slowing to 6.5% in September, the weakest pace  in over two years. In contrast, house price inflation ex Dublin has picked up , rising to  11.4% on the CSO figures.

The Central Bank has therefore precipitated a slowdown in mortgage lending and  helped to dampen house price inflation in the Capital but given the rate of house completion there is little prospect of a change in the trend for residential rents, absent a severe demand shock to employment.

Euro and Oil price likely to prompt ECB action

The Euro Area has experienced economic growth for eight consecutive quarters and the pace of expansion this year is likely to average around 1.6% from 0.9% last year.  Most forecasters, including the ECB, expect that pace of growth,  of around 0.4% a quarter, to continue into next year and alongside  rising oil prices is projected to lead to a pick up in inflation , to 1.1% in 2016 and 1.7% the following year, and as such nearer the  target level. Recent developments in the exchange rate and the oil price may prompt a forecast revision, however, and the ECB has just flagged that it may take further policy action in December, contingent upon an updated inflation forecast.

Headline inflation. which had been negative early in 2015, turned positive in the Spring but has weakened again of late, with September recording another negative number (-0.1%). Energy prices fell by 1.7% in the month and are down some 9% on an annual basis, which  of itself reduces the overall inflation rate by 1 percentage point. Core inflation is also weak, however; prices rose by just 0.9% if one excludes food and energy while inflation in  services, which accounts for over 40% of the index, is just 1.2%.

The current ECB forecast is predicated on a rise in oil prices to an average of $56 a barrel next year, but this now looks too high; the current forward price of Brent implies a figure around $52. Moreover, the ECB expects the euro to average $1.10 , and as such are clearly concerned about the currency’s recent performance, with a 7.5% appreciation against the dollar since the Spring, taking it above $1.13 from below $1.06, and a 6.5% rise in the trade weighted exchange rate. Consequently, the forecast price of oil in euro terms of €51 now looks wrong on two counts, and may be closer to €46 in the December forecast in the absence of a significant fall in the euro on the FX markets.

Engineering such a fall may be difficult in the absence of stronger US data and a tightening of monetary policy by the Fed but the ECB is likely to take some measures. President Draghi took a step in that  direction at today’s press conference by opening the possibility of a cut in the rate the ECB pays for overnight deposits from the banking system. The Deposit rate was cut to -0.2%  over a year ago and Draghi had indicated that it was at the effective lower bound but that may no longer be the case, judging by his latest remarks.

Apart from a Deposit rate cut the ECB has also indicated that it will use other instruments to ease policy further if deemed necessary. The simplest. and most likely, is an expansion of the current asset purchase scheme , which could take the form of a higher volume of monthly purchases , a broadening of the assets deemed eligible or a prolongation of the time frame of the programme.

It may well be that we are at the effective limits of monetary policy, and further QE may be both ineffective and political troublesome for the ECB, as it carries implications for income distribution. Some council members have talked about the need for non-policy measures and it may well be that the whole fiscal policy debate will be reopened but for now the ECB remains the only game in town.

Government to spend tax bounty in final three months of this year.

Earlier in the year the Irish Government spelled out what the EU rules  on   Exchequer expenditure meant for the 2016 Budget; the fiscal space available was around €1.3bn, which could be used to fund tax reductions or spent. That figure then became a €1.2bn to €1.5bn range, with the Coalition indicating a probable 50/50 split between additional expenditure and tax cuts. What is now clear, following the overnight release of the White Paper on Receipts and Expenditure, is that spending will  be substantially higher than initially planned in 2015, thanks to a spree  over the final few months of the year. Essentially, the authorities are choosing  a deficit  of 2.1% of GDP instead of the 1% figure that might have been achieved.

Tax receipts were originally  expected at €42.3bn this year but by April the Department of Finance had revised that figure up by €1bn,  and it soon became obvious that the outcome would higher still. Finance now expect €44.6bn or €2.3bn (5.4%) above the initial target. Non-tax receipts are also stronger than forecast, by some €0.4bn, thanks to higher profits at the Central Bank, while savings on debt interest provided an additional windfall for the Exchequer.

The Government now plans to spend most of that unexpected bounty. Voted current expenditure ( essentially day to day government spending) was projected to fall  to €38bn in 2015, from €39bn in 2014,  and has been running  marginally below profile year to date, coming in at €29bn at end-September. Spending could  therefore amount to  €9bn over the final three months of this year to hit the Budget figure. The White Paper shows that spending will  now end the year at €39.5bn, which implies  €10.5bn will be spent in just three months .

The capital deficit is also larger than it appeared likely,  at €1.7bn, with money transferred  from the Exchequer to the Ireland Strategic Investment Fund. Consequently the Exchequer cash deficit ( current budget balance plus capital balance) is now projected at €2.8bn, with the General Government deficit ( the EU’s preferred fiscal measure) at €4.4bn. Finance has also revised up its forecast for Irish GDP this year, to €210bn, so the deficit equates to 2.1% , substantially below the initial 2.7% target but also well above what might have been achieved had the Government chosen to adhere to  the  initial spending plans.

As to 2016, Finance expects current receipts to rise by over €2bn and expenditure to be broadly unchanged, resulting in a current budget surplus,  which  alongside a modest capital deficit gives an  Exchequer cash deficit of  only €0.8bn.The General Government deficit is projected at €1.9bn, or 0.8% of projected GDP. There is an argument that the economy does not need any additional stimulus ( GDP is deemed to be operating at  2.5%  above potential by the EU) but it appears unlikely that the 2016 Budget will  not use the available fiscal space of up to €1.5bn, taking the post-Budget deficit forecast to €3.4bn or 1.5% of GDP. On our estimates this would imply a structural budget deficit of 2.6% ( i.e. taking account of the economic cycle and the official view that we are in a boom) against a 2015 outturn of 3.2%, so the decline would be above the 0.5% required under EU rules.