Irish Mortgage arrears; pace of decline is slowing

Irish mortgage arrears are still extraordinaily high by international standards , although the past few years have seen a significant decline. The  number of  Principal Dwelling Home (PDH)  loans in arrears over 90 days  , the standard measure, peaked in the autumn of 2013 at just under 99,000 , equivalent to 12.9% of the total  outstanding. and in the final quarter of 2016 had fallen to some 54,000 (7.4%). The trend in the Buy To Let (BTL) sector is broadly similar, although the peak there was later, in the second quarter of 2014, at some 32,000, equivalent to more than 1 in 5 of the outstanding stock. The BTL figure has now declined to 15,500 or 15.7%.

What drives arrears?  Research has generally shown that there are three main factors; unemployment, house prices and interest rates. Indeed, we developed an equation predicting PDH arrears based on these variables which performed very well for a time, capturing the decline. That fall was largely driven by lower unemployment, but the recovery in house prices was also important, with a resultant reduction in the numbers in negative equity. The latter peaked at over 300,000 in 2012, according to the ESRI, and on our estimate fell to around 50,000 at the end of 2016.

Unemployment is still falling, of course, but the number in arrears has been consistently higher than our predicted figure for some time now. In fact it is clear the pace of arrears decline has slowed; the  PDH fall in the second half of 2016 was just 3,300  against over 8,300 in the same period a year earlier. The BTL decline in the latter half of 2016 was less than 1500.

This suggests that the arrears issue is moving into more intractable territory, with the  total numbers (PDH plus BTL) in arrears  for more than 720 days still over 47,000. Moreover, the flow of mortgages into arrears ( i.e. in arrears for less than 90 days ) actually rose for both PDH and BTL in the final quarter of 2016, the first rise in four years.

Reposessions are also rising in Ireland, for a variety of reasons, although about half are voluntary, with the quarterly flow now at around 700, from less than 400 in 2014. This is equivalent to less than 4% of the arrears figure and again unusual relative to elsewhere, this time very low.

The arrears issue is not going away any time soon.

The Return of Inflation?

Inflation in the Euro Area has risen sharply of late, with the flash estimate for February at 2%, from 0.6% in November, and is now  at the highest rate in four years. Consumer prices have also picked up momemtum in the other major economies: In the UK the inflation rate has accelerated from 0.9% to 1.8% in four months while in the US the increase is from 1.6% to 2.5% over the same period. As a consequence markets have shifted away from the fear of deflation and now the issue is whether this upturn in prices will prove short-lived or is it the beginning of a more sustained period of inflation, ultimately requiring  a faster policy response than currently priced in to markets. That change is clearest in the US, with the Fed now expected to raise rates again this month.

The more benign interpretation of the inflation trend  is supported by measures of core inflation, which exclude volatile components like Food and Energy. On that definition, the euro inflation rate is at 0.9%, unchanged over the last three months, and so the rise in inflation is due to a rebound in energy prices ( up an annual 9.2% in February) and unprocessed food ( plus 5.2%). These changes partly reflect base effects ( large monthly falls a year ago now dropping out of the annual figure) and the recent increase in global commodity prices, notably crude oil. In the US the Fed’s preferred measure of inflation is the core consumption price deflator, and that is rising at an annual rate of 1.7%, or at an annualised  rate of 1.6% over the past three months, again not flashing red.

What determines core inflation? Profit margins have an impact ( can firms pass on higher import prices in the UK for example) but the main factor is labour costs, and in most countries wage growth remains subdued and is much lower relative to unemployment than in the past. Why this is the case is the subject of much debate but in the absence of a pronounced pick up in wage inflation it is difficult to see price inflation accelerating for a prolonged period.

Headline inflation is what matters to consumers, of course, and the recent rise will dampen real incomes and  probably reduce real consumption and hence GDP growth. A 2% inflation rate is therefore  worse for the economy  than a 1% rate, yet Central Bankers have argued the opposite, as most use a 2% inflation figure as their definition of stable prices. How this became conventional wisdom is hard to fathom ( prices rise by 22% in a decade and just shy of 50% in 20 years, hardly a good measure of stability) while the fear of deflation is strong, even though Japan, the land of falling prices, has not really suffered in terms of its real GDP growth per head. Inflation at 2% may be fine with wage growth of 4%, as was the case , but not if wage growth is 2% or below, as appears to be the ‘new normal’. There is not much central bankers can do in the short term to influence energy or food prices, of course, but higher headline inflation will dampen real spending in the absence of an acceleration in nominal wage growth.