Irish mortgage controls having big impact on credit and Dublin prices

The Irish Central bank introduced controls on mortgage lending a year ago, including an 80% loan to  value limit on most owner-occupied properties , alongside a 3.5 loan to income ceiling. First Time buyers can borrow up to 90% loan to value for a property below €220k, which implied that the partial exemption would only be relevant outside the Capital; prices in Dublin probably average around €300k, against €175k across the rest of the country. The Bank’s own research suggested the controls would dampen credit growth and reduce housing supply, with a limited impact on prices. There is undoubtedly a case for such controls, particularly in an era of historically low  interest rates, but the timing appeared questionable given that credit has been contracting in Ireland since early 2010, with any new lending more than  offset by repayments.

The latest data, just published, indicates that the controls are having a pronounced affect on  new lending and are impacting house prices. Mortgage approvals for house purchase had been rising strongly (by an annual 40% in q1 2015 for example), albeit from a very low base, but that growth has stopped and approvals are now falling sharply; the annual decline in the final quarter was 20.3%, with December alone showing a 23.7% fall. There is not a consistent relationship between approvals and drawdowns but the trend in the former implies around 6,000 loans for  house purchase  in q4 against over 6,900 a year earlier.

One would expect the controls to bite harder in Dublin than elsewhere and the December data on residential property prices supports that view. Prices in the Capital , having risen by over 22% through 2014, fell in the first quarter of 2015 before regaining some momentum over the summer months and then fell again in the final quarter, by 0.7%, leaving the annual increase in December at just 2.6%. Prices ex-Dublin also fell marginally in the first quarter, implying an expectation  effect from the controls, but  picked up strong momentum in the latter months of the year. Indeed, the 5.8% rise in the three months to October was the strongest recorded by the CSO index, which starts in 2005, and other evidence shows that one has to go back to the late 1990’s for comparable gains. The pace of growth has slowed a little, with prices rising by  3.6% over the final three months of the year, leaving the annual increase in December at 10.2%, the same as in 2014. Some slowdown in Dublin prices was no doubt inevitable but the contrast between the Capital and elsewhere is striking, indicating that  would-be buyers in Dublin may be looking further afield.

The Central Bank has indicated that it will assess the impact of the controls in mid-2016 although the pace of contraction in new lending may prompt a speedier review, as one doubts it was anticipated.

The Price of Oil

It is not that long ago that the price of crude oil approached $150  a barrel (a barrel of oil equates to around 35 imperial gallons) and  the airwaves  were full of discussions on  ‘peak oil’ and the possibility of $200 as a realistic price forecast. In the event prices collapsed in the wake of the financial crisis , declining to around €35, before recovering and stabilising at over $100 from 2011 to mid 2014. Prices then fell precipitously, to around $50, before rallying briefly in the early months of 2015  but then the slide resumed, with the downward momentum increasing in recent months, taking Brent crude,the European benchmark, below $30 for the first time in over a decade.

The demand for oil is very unresponsive to price changes in the short term (in economic terms the price elasticity is close to zero) so any change in supply will have a large impact on price, be it on the upside or the downside, but it is useful to distinguish some medium term factors affecting the market from some shorter term developments.

The demand for oil will rise with economic activity and so it is not surprising that global demand in 2015 , averaging 94.5 million barrels a day (mbd ) according to the IEA, is considerably higher than it was before the crash in 2007 (86.5mbd). What is surprising though is that demand in the developed world (OECD countries) is actually 3mbd lower now than it was  eight years ago, leaving emerging markets as the driver of the increase in world demand for crude, with China being particularly important (it now accounts for 12% of global oil demand from 8% in 2007).

There have also been some fundamental changes on the supply side of the market. Non-OPEC supply has risen by 7.5mbd since 2007, from 50.9mbd to 58.4mbd, driven by a surge in production from North America, where output has risen to 19,8mbd from 14.3mbd. Consequently , the implied call on OPEC supply has not greatly changed and the cartel’s market share has fallen. In the past Saudi Arabia has acted as ‘swing’ producer in OPEC, cutting output in order to stabiise prices at times of excess supply, but it changed policy in 2014, seeking to maintain market share, Iraq’s output has also risen substantially ,  and the resultant increase in OPEC output has contributed to persistent excess supply in the market; supply exceeded demand by  1mbd in 2014 and by a further 1.8mbd in 2015. Stocks have therefore risen sharply and the scale of the overhang has clearly put huge downward pressure on crude prices.

In terms of shorter term factors, global growth has consistently disappointed (the IMF has again reduced its  forecast for 2016) and China is slowing, so the market has scaled back estimates of oil demand growth for this year (the IEA expects 1.2mbd). Non-OPEC supply may actually fall a little but this is likely to be more than offset by higher Iranian output (now that sanctions have been lifted)and from other OPEC members, so the consensus is that excess supply will grow in 2016, albeit at a slower pace than of late. In addition, global demand fell unexpectedly in the final quarter of 2015, back to 95mbd from 95.5mbd, as a result of an  unusually mild early winter  in the Northern Hemisphere, but supply was broadly unchanged at 97mbd, exacerbating the excess supply issue.

The plunge in oil prices obviously benefits oil importers and  hurts oil producers so the global impact is difficult to disentangle. The IMF believes that the boost to real consumer incomes (via lower retail fuel prices) and the  reduction in  energy costs for firms offsets the  loss of spending power from oil producers and investment in oil production,; global growth may be boosted by over 1% as a result of the recent price falls, according to the Fund. Others disagree, arguing that the cut in investment spending in the US on oil production, for example, is offsetting the impact of lower fuel prices for consumers. The positive correlation between equity markets and the oil price of late implies investors believe the latter or see the price decline as demand driven rather than from the supply side, That does not fit the facts, however, and although it is anyone’s guess how low prices will go in the short term one doubts if the marginal cost of oil production is $30 or below so prices at that level or lower are not sustainable.

Record rise in Irish Household real incomes in 2015

In the absence of some wild data revisions it would seem that the Irish economy grew by at least 7% in 2015, and a few weeks ago it emerged that tax receipts rose by 10.5%, providing further evidence that last year was indeed extraordinary in economic terms. The CSO  recently published figures on sectoral income and savings, taking in the third quarter of 2015, and they show that households also saw a spectacular growth in disposable income- indeed, in terms of spending power, the rise outstripped anything seen in the Celtic Tiger era, albeit coming after a longer series of declines.

Irish Household disposable income peaked in 2008 at over €100bn and then fell for five consecutive years, to under €86bn, a decline of some 15%, reflecting a plunge in employment, falling wages and a rise in average tax rates. Consumer prices were broadly flat over that period so the decline in real income was also around 15%.

The recovery in 2014 was modest, with nominal income rising by 2.7%, but last year saw a sharp acceleration; the annual pace of growth rose from 5% in the first quarter to over 8% in q3. Consequently, absent revisions ( which can be large) household disposable income probably grew by around 7.5% last year, fuelled by strong employment growth and an acceleration in average earnings. This would leave the nominal increase below that recorded in 2003 (7.9%) , 2005 (9.8%) and  2007 (8.6%), when employment growth and wage increases were stronger, but consumer price inflation was also higher over those years, so eroding some of the gains in real terms. CPI inflation in 2007 was 4.9% for example, and  2.5% in 2005. In contrast, the CPI index actually fell in 2015, by 0.3% , so in real terms the rise in disposable income last year is far stronger than recorded in the boom years.

The recession prompted households to boost precautionary savings and repay debt  with the  result  that the gross savings ratio (the proportion of disposable income not spent) rose from 5.8% in 2007 to a peak of 14.1% in 2009. Since then it has declined steadily, falling to 5% in 2014, although the strength of income growth last year seems have caused a significant rebuilding of savings, with the seasonally adjusted ratio rising to 10.3% in the third quarter and implying an annual figure of perhaps 8%.

The income and savings data confirm that households are in better financial shape than they have been for a long time and in that context it is perhaps less surprising to see consumer confidence at a 10-year high.

The Irish Exchequer’s Annus Mirabilis

It is not uncommon for the Irish fiscal balance to end the year in a very different position than envisaged at the time of the Budget presentation and 2015 has seen more of the same, albeit with a larger than normal  forecast error. This  time the divergence is on the positive side, with the Exchequer emerging with a  cash deficit of just €62mn instead of having to borrow €6.5bn as originally projected. As a result  the level of debt will be lower than forecast and the debt ratio in 2015 may be below 96%  of GDP from 107.5% in 2014.

A key factor in the much better than expected outcome is a number of unbudgeted capital receipts, amounting to almost €4bn.  Early in the year the National Pension  Reserve Fund transferred €1.6bn from the sale of Bank of Ireland shares to the Exchequer, with the latter then benefitting from the sale of Permanent tsb shares (€0.1bn)  and Capital notes (€0.4bn) . The sale of the State’s holding in  Aer Lingus  netted another €0.3bn and in December the Exchequer received €1.5bn from AIB, with the latter redeeming  part of the Preference shares issued in 2009.

Current receipts were also much stronger than expected in 2015. Non-tax revenue came in at €3.5bn instead of the €3bn projected, largely reflecting higher profits at the Central Bank, and tax revenue was €3.3bn or 7.8%  ahead of the initial Budget forecast. This  was in part due to much stronger than expected economic activity ( real GDP probably grew by at least 7% last year against a 3.9% forecast) which led to overshoots in income tax (€379mn), VAT (€170mn)  and Capital taxes (€254mn). However the main driver was an extraordinary forecast error in terms of Corporation tax, which emerged €2.3bn or 49% above the original projection.

On the spending side, debt interest was €0.7bn below forecast, offset by higher  voted current expenditure, following a decision in October  by the Government  to spend some of the unexpected tax bounty,  Nevertheless, total current spending was only marginally ahead of the original Budget target and 1.3% lower than the 2014 outturn. Overall, the current Budget was in deficit to the tune of just €4mn which alongside a capital deficit of   €58mn produced the €62mn Exchequer shortfall.

The General Government balance , the preferred EU fiscal measure  , excludes transfers across the Government sector and includes additional adjustments which have to be confirmed by Eurostat. It would seem though that the General Government deficit is likely to be around €3.2bn,  which is  €2bn below the original projection  and  equates to 1.5% of GDP , against  the Budget target of 2.7% and the revised 2.1% estimate made a few months ago.

The 2015 fiscal outturn also means that  the 2016 Budget assumptions now look redundant. The latter envisaged a 5.8% increase in tax receipts from an expected base of €44.6bn, giving a 2016 tax figure of €47.2bn. That now only requires a rise of 3.5% to achieve given the €45.6bn figure actually received in 2015.  So if tax receipts do indeed rise by 5.8% this year’s figure will emerge at €48.2bn or €1bn ahead of the target announced in October’s Budget. On that basis the projected deficit of €2.8bn could be €1.6bn, or just 0.7% of GDP instead of the 1.2% currently forecast.

On the face of it then the Irish fiscal situation has been transformed and the outlook is indeed positive although there are two caveats. One relates to the international backdrop, which may be less supportive for the economy in 2016. Another relates specifically to Corporation tax, the source of over two-thirds of the tax overshoot last year. A forecast error of that magnitude clearly raises the risk around any projection  of the corporate tax take in 2016 and hence the overall revenue figure.