The wrong kind of Inflation

The past decade has seen inflation in the euro area average just 1.1% a year (the Irish figure is even lower, at 0.6%) which one might think was close enough to stable prices to satisfy the ECB’s mandate as set out in its statutes. However, an annual inflation rate ‘below 2%’ was initially set as a target by the ECB, then modified to the curious ‘ below but close to 2%’ and recently changed again to a flat 2%. The evidence would indicate that the Bank can neither control nor indeed forecast inflation with any degree of accuracy, although it would argue the counter factual-that inflation would be lower in the absence of its monetary policy measures- albeit based on the same models that have consistently over-predicted inflation in the past.

Forecast inflation remains a cornerstone of the ECB’s monetary stance, nonetheless, and its updated forward guidance sets out three conditions required before any upward move in interest rates. The first is that inflation should reach 2% well ahead of the forecast horizon. The second is that inflation is expected to remain there ‘durably’ for the rest of the projection period while a third requires that the outlook for core inflation also be consistent with a headline rate of 2% in the medium term.

Has the re-opening of economies this year precipitated any change in this disinflationary picture? In the short term the answer is yes as EA inflation has accelerated strongly in recent months and is currently at 3%, with a higher figure widely expected near term. On the face of it then one of the three ECB conditions for tighter policy has been met but forecast inflation in 2023 in their latest projections is still far below target , at 1.5%, Clearly, then, we have the wrong kind of inflation as far as the ECB is concerned. Higher oil prices are certainly a factor, but excluding energy EA inflation jumped to 1.7% in August. The reversal of the VAT cut in Germany in 2020 is also seen as factor, although inflation is above 2% in 15 of the 19 euro members, implying a broader driver, which the ECB identifies as ‘cost pressures that stem from temporary shortages of materials and equipment’. Base effects stemming from price falls last year are also important and in a recent presentation Isabel Schnabel, an Executive Board member,included a chart with inflation measured as the change in prices over two years, so removing the Lockdown year of 2020 from the picture.

Prices can rise from either an increase in demand or a fall in supply and the ECB clearly believes the latter is at play, with the impact fading next year. That may not be the case but it is striking how little inflationary pressures the Bank perceives as existing over the next few years, despite cumulative GDP growth of 12% in 2021-23. Indeed, in an alternative scenario , with growth at a cumulative 14% ,headline inflation is still well below target in 2023 , at 1.7%.

String GDP growth does drive down unemployment in the forecasts, with an UR rate falling to 7.3% in 2023 from 7.9% this year in their benchmark case. Despite this, wage growth is seen to slow, to 2.5% from 3.5%, so labour costs remain benign, as in pre-pandemic forecasts. Market expectations on inflation in the longer term have moved higher although still well below 2% and while longer term rates have also risen of late they are still consistent with negative policy rates for another 5 years, so investors would seem to broadly share the ECB view that nothing much has fundamentally changed in term of inflation.Given the reports of wide- scale labour shortages in some industries it may well be the ECB wage assumption that proves wrong if inflation does not ease as Frankfurt and the market expects.

Mortgage Controls Dilemma for Central Bank

The Central Bank of Ireland introduced mortgage controls in 2015 and although there has been some modifications over time two restrictions still lie at the heart of the regulations, one on Loan to Value (LTV) and the second on Loan to Income(LTI). The latter limit is 3.5 (of gross income) although banks are allowed to exceed that for up 20% of their lending to First Time Buyers (FTB).

The controls are designed to increase the resilience of borrowers and lenders to economic shocks and hence reduce the probability of a repeat of the housing crash, with banks also now required to hold substantially more equity capital. The data confirms that leverage in the market is certainly a lot lower now than towards the end of the Celtic Tiger period; the median LTI for FTBs in 2020 was 3.2 against 4.5 in 2008, with 10% of loans then above an LTI of 6, compared with a figure of 3.8 last year. We cannot be sure of how lending would have developed absent the controls but the Central Bank believes that house prices and credit would be much higher, as indeed would be housing supply.

The Central Bank reviews the controls annually and will do so again this year, although this time will examine the ‘overarching framework’ as well as consulting with the public, the people the measures are designed to protect. This perhaps suggests a more fundamental change is possible and one can put forward a number of reasons why this might be the case.

The first is that the ECB and the Central Bank are concerned about the low level of profitability of European and Irish banks. All suffer pressure on net interest margin from negative rates but Irish banks are also faced with a contraction in credit to the private sector, unlike their European counterparts. Mortgage lending in Ireland is growing, but at an annual pace of 0.7% against 5.4% across the euro area.

Second, the number of active mortgage lenders here is due to contract with the proposed exit of two banks, KBC and Ulster, leaving three main providers of credit, alongside a small number of niche players.

Third , Ireland is the only euro country with an LTI limit, as it takes no account of the interest rate cycle. For example, the average new FTB mortgage last year was €241,000 which at the average interest rate of 2.8% equates to a monthly cost of just over €1000 or only 15% of the average income of borrowers (over 70% are joint applications). The same mortgage at an interest rate of 5% would cost €200 a month more and equate to 20% of that income. A current mortgage is therefore not expensive in terms of servicing and is below the average cost of renting a property, which makes little sense. That is why a debt service limit is far more common in Europe and the argument used against its introduction here in 2015 (the credit register was not fully operational) is no longer valid.

Loan to value limits are also a standard feature of mortgage controls elsewhere, and in Ireland the limit is 90% for FTB’s but here the Government’s Help To Buy scheme will allow such buyers to reclaim up to €30,000 in previously paid tax , so rendering that constraint less meaningful.

On the face of it then a move to a debt service ratio makes a lot of sense and depending on how it is set might well stimulate additional lending. This might be problematical though if house prices are rising strongly and that could indeed be the case. Prices fell last summer but have recovered since, increasing by an annual 4.4% in April and 5.3% excluding Dublin. This is actually slower than the euro norm but momentum appears to be building, with Daft,ie reporting asking prices rising by 13% in the second quarter. So it will be a fine balancing act for the Central Bank, to change the controls in a meaningful way without adding to price pressures.

7.8% increase in Irish GDP shatters consensus forecasts

Another big surprise in the Irish national accounts, with GDP expanding by 7.8% in the first quarter of 2021. The more timely data on retail sales , credit card spend and construction implied a sharp fall in domestic spending in q1 but industrial production had grown strongly, pointing to robust export growth. In the event the latter proved the more significant, at 5.8%, so dwarfing falls in the domestic spending components. The quarterly surge allied to a positive base effect (GDP fell 3.9% in the first quarter of 2020) propelled annual GDP growth to 11.8%, not only shattering estimates for the quarter but also rendering redundant consensus estimates for the full year.

The export surge (the annual increase was 18%) owed much to an 68% rise in contract manufacturing, which are goods manufactured offshore but owned by Irish based firms. Most of that production is presumed to be in China so the strong re-opening of that economy may be reflected in these numbers.

Consumer spending did fall, by 5.1%, taking the annual decline to some 12%, although a rebound to a positive figure is likely in q2, while Government spending is still supportive, rising an annual 13.4%, albeit only 1% in the quarter.Building and Construction fell an annual 19% with big declines in investment in machinery and Intangibles resulting in a 63% plunge in overall spending on capital formation.

Most of the spending on Intangibles is also captured as a service import, and that duly fell ,as did the import of goods, given the fall in consumption- imports in total declined an annual 25%. The export performance also led to unusually large profit outflows, so reducing the annual growth in GNP, which adjust for international profit and interest flows, to 2.9%.

Domestic demand overall fell by an annual 39%, but the CSO estimates that the decline in modified domestic demand was 5.8% This adjusts for the impact of aircraft leasing on investment in machinery and equipment as well as removing the impact of multinational spending on Intangibles, although of course also ignoring all exports from whatever the source.

These GDP figures again illustrate the dual nature of the Irish economy, with exports dominating domestic demand in total economic production. Moreover exports do not conform to the cyclical pattern used in most economic models., and are more akin to the performance one sees in secular growth stocks.

The Irish economy grew by 3.4% in 2020, outpacing China.

Ireland appears to have been the only country in the Euro Area to record economic growth last year, with real GDP rising by 3.4%., which also means it outpaced China (2.3%). Nominal GDP is now €366bn, and it has actually doubled in seven years. The 35% rise recorded in 2015 plays a significant part of course but excluding that year the average rise in nominal GDP since 2013 is 7.2% and 6.2% in real terms, a remarkable performance.

Growth in 2020 was achieved despite big Lockdown related falls in domestic demand, including a 9% decline in consumer spending and a 10% fall in building and construction. The contraction in investment spending on machinery and equipment was larger, at 25%, while the decline in Intangibles (R&D and Intellectual Property ) was 35%, bringing the total fall in investment spending to 32%.

Government spending rose substantially, including large transfers to support household and businesses, and the increase in Government consumption in the national accounts was 10%. However, the Government component in GDP is so small now that the net impact on growth in 2020 was less than 1%. The main reason the Irish economy grew last year was the performance of the export sector, which due to its composition (chemicals, pharma, and ICT) performed very well despite the pandemic, rising by 6.2% in volume terms , with all of the growth coming in terms of merchandise exports.The corollary to that export gain was higher multinational profits but overall factor outflows actually fell, albeit offset by a larger fall in investment income inflows , leading to a big rise in net outflows. Consequently GNP growth was much weaker than GDP, at 0.6%.

The 2020 growth figure was achieved despite a large seasonally adjusted 5.1% fall in GDP in the final quarter, although the component breakdown is a little odd, in that exports grew by over 4%, but that was outstripped by a 24% increase in imports. The latter is subtracted from the GDP measure but looks high relative to the consumption and capital formation figures and we would not be surprised if the Q4 figure is not revised upward.

Absent that revision the big fall in the final quarter left the annual change in GDP in q4 at just 1.5%, a much lower carryover effect than we anticipated. Growth in GDP over the first half of 2021 will be flattered by positive base effects but the economy is now entering the year with far less momentum which allied to the Lockdown over q1 has negative implications for the 2021 growth figure as a whole..

Wealth ,Debt and Snowballs

In the past week the Central Bank published its latest figures on the balance sheet of Irish households, covering the third quarter of last year, while the Department of Finance produced its annual thoughts on Government debt. The latter tends to generate more column inches, raising the question of whether the level of debt owed by the State is too high or in some way represents a major problem, while the ongoing extraordinary shift in household debt and wealth receives less attention.

On the latter Irish households are continuing the process of deleveraging which started in 2009 with debt of just over €200bn, equivalent to 210% of disposable income at the time. Since then the economy has recovered and then boomed, moving to full employment in 2019, while interest rates have fallen sharply , including mortgage rates which are currently at all-time lows, yet household debt has continued to fall in cash terms, declining to €130bn on the latest figures. The change in term of disposable income is more pronounced still, with the ratio at 107%, back to the range last seen twenty years ago.

Housing is the main asset on the other side of the balance sheet, and the property crash was the main driver of a collapse in net household wealth (i.e, assets minus debt); from 2008 to 2012 if fell from over €700bn to a low of €430bn. Since then the recovery in the housing market has been a big driver of the rise in household net wealth, which reached a new high of €831bn in q3. The long rally in equity markets has also helped boost pension assets while the past year has also seen a significant increase in holdings of liquid assets in the form of cash and bank deposits. This had started before Lockdowns but in effect households have become forced savers given the reduced options to spend.

As a result households now hold €163bn in cash and deposits which exceeds debt owed by €33bn, a far cry from 2008 when debt exceed deposits by €85bn. Of course these are aggregate figures and some households have few or no assets and a lot of debt while the reverse is also true. The change has been bad news for Irish banks, which have seen assets fall and deposits surge in relation to shrinking loan books.

The path of Government debt has been very different. Gross debt soared in response to the financial crash, reaching €215bn or 120% of GDP in 2015. From there it fell a little in cash terms but very significantly relative to GDP given the growth of the Irish economy, declining to 57.2% in 2019, one of the lowest ratios in the EA and below the 60% figure required under the Stability and Growth pact. The Irish Government responded to the Covid pandemic by significantly increasing transfer payments to households and firms, as elsewhere, and the debt figure ended last year at some €220bn, albeit still with a low debt ratio of around 61% given that Irish GDP probably grew.

Government Debt is potential problematical for two reasons. One is the annual cost of servicing it, which means Government spending diverted from other areas. That cost will in turn depend upon the debt stock and the average interest rate on that debt and thanks to the ECB the latter has tumbled; the average cost of Irish debt is now under 2% , less than half the rate in 2013, because Ireland can refinance maturing debt at a rate close to zero and even below for shorter dated borrowing. As a result debt payments costs the Government under 5% of total revenue, versus 17% five years ago.

Governments rarely run large budget surpluses for any period of time so debt is generally simply rolled over rather than repaid out of revenue i.e. if €15bn is due to mature in a given year the authorities will issue €15bn to fund it, plus any additional borrowing if there is a fiscal deficit. That raises the second issue for Debt- can the Government readily refinance maturing bonds. That depends on investor appetite and in general is affected by who owns the debt and expectations about repayment, with the debt ratio playing a key role in that expectation.

Japan has a debt ratio of 240% but few expect a default, in large part because most of the debt is held internally, by banks, the Central Bank, insurance companies and pension funds. So Japan owes the debt to itself and these holders are also far less likely to sell it before maturity. That example also highlights that expressing the debt relative to the population is not meaningful, as it ignores the ownership issue. In Ireland’s case domestic ownership is actually not high but over €40bn of the total is owed to the EU on very long maturities and of the €140bn of bonds at issue over €50bn is held by the Central Bank and the ECB .These bonds have to be repaid of course but the interest is largely recycled back to the Exchequer and the large holdings under QE and PEPP means less bonds available to investors who might sell before maturity, perhaps precipitating a spike in bond yields and hence raising issues about refinancing, as happened in 2010.

On the debt ratio itself, its evolution over time depends largely on two factors ( ignoring one-off impacts like asset sales) – the fiscal balance excluding debt interest (the primary balance ) and the difference between the rate of interest on the debt and the growth rate of GDP. In Ireland’s case, and indeed in many developed economies in recent years, the interest rate (r) is now well below the growth rate (g) and this ‘snowball effect, as it is known, has been a big factor in the fall in the debt ratio. So, let’s say,. Irish GDP grew at 5% a year over the next five years with the interest rate at 2%, the debt ratio would fall by around 3% a year, assuming a primary budget balance, down to 53% from the current 61%. By extension, given that snowball effect the Irish Government could actually run a primary fiscal deficit of around 3% per annum and maintain the existing debt ratio.

The fact r<g in many economies has been a big factor in changing attitudes to debt, with the IMF, for one, completely changing tack from its pro-austerity stance of recent years, now arguing for large fiscal stimulus. Of course rates may rise in the future and QE may one day end but that is likely to be some way off. So as it stands Ireland does not have a debt problem given the debt ratio , the interest rate and the ownership of that debt. Why then are some concerned? One answer is that it is argued GDP is not a good measure of Irish income and as such a better denominator to use is modified national income, a specifically Irish concept which adjusts GDP for various multinational related flows. On that metric the ratio is thought to be around 107% in 2020, a lot higher than 61% but still not excessive by EU standards. In this writer’s view the concept is not useful anyway and was an overreaction by the CSO to the 2016 GDP figures (the release precipitating the ‘leprechaun’ saga). No other statistical agency recognises the concept, it is impossible to forecast and in any event appears to have a very similar tax elasticity to GDP anyway (indeed Corporation tax is more closely related to GDP).

Irish economy again confounds, up 11.1% in q3

We have noted on other occasions that the Irish economy, as measured by GDP, behaves more like a secular growth stock than the cyclical entity forecasters generally assume, reflecting the strength and composition of the multinational export sector , driven as it is by ICT, Pharma and medical devices. The widely expected external trade downturn never materialised, which also raises questions about the forecast impact of Brexit on the export sector and hence the broader economy.

Exports rose by 5.7% in volume terms in the third quarter, which alone would have boosted GDP by 7.4%. Growth wa stronger still, however, as domestic spending benefitted from the re-opening of the service sector over the summer months. Consumer spending had fallen by 19% in q2 but jumped by 21% in q3, adding over 5 percentage points to overall GDP, while building and construction also soared, by 40%, although Government consumption was flat after rising by over 9% during the Lockdown in q2.

Spending on machinery and equipment also rebounded strongly in the quarter although multinational investment in R&D, by far the largest component of investment, rose only modestly, so reducing the growth in total capital formation to 4%. That also dampened imports, which rose by 1.5%.

The reported decline in GDP in the second quarter was revised to -3.2% from -6.1%, and the blow-out q3 figures left the annual change in GDP at 8.1%, despite the fact that investment and consumer spending are still down on last year. That’s plus 8.1%, with the average annual growth over the three quarters of 2020 at 3.6%, so absent an enormous fall in the final quarter growth is likely to be positive for the year as a whole. A better gauge of the income of Irish residents is GNP, which adjusts for net profit outflows, and the average annual change over the first three quarters is only marginally positive, albeit still a much better performance that the EU norm.

Inflation: Dodo or Phoenix?

In the late 1970’s and early 80’s annual consumer price inflation in Ireland hovered around 20% and it would have seemed fanciful to anyone living through that period there would come a time when prices would hardly change from one year to the next. Yet, annual Irish inflation since euro membership in 1999 has averaged 1.8% and has been lower still in the last decade , at just 0.5%. Of course Ireland has not been unique in this regard, with inflation in the euro area averaging 1.4% over the past decade or 1.2% excluding food and energy.

The Covid pandemic has added additional disinflationary forces, with the demand shock trumping that on supply, at least to date, and annual inflation is currently negative across the euro area, including Ireland. Some argue , though,that this long period of largely stable prices may be coming to an end, in large part as a consequence of the policy measures taken to combat the economic dislocation caused by the pandemic.

Inflation, as Friedman noted, is everywhere a monetary phenomenon and the money supply is certainly expanding at a rapid clip in developed economies; in the US broad money supply growth was an annual 23% in August, while the July figure in the euro area was over 10%, including 13.2% in Ireland. In fact most of this is driven by overnight deposits, as households, in particular , are effectively forced savers as a result of economc restrictions, leading to a rapid build up of monies in current accounts that would normally be spent.

How quickly these deposits will be spent on a return to more normal conditions is one question but the broader monetary argument is that banks in Europe and the US now have an unprecedented amount of excess reserves, which can be used to create loans and hence money, so the potential is there for a longer period of excess monetary growth and inevitable inflation.

The Monetarist case is based on the Quantity Theory, which has an identity at its core- the value of national income (PY) equals the money supply (M) times the average number of times that money circulates ( V, the velocity of circulation). The theory assumes that V is pretty stable which if true means that monetary growth above the potential growth of the real economy will push up prices. V can and does fall, however, so ‘excessive’ monetary growth may simply be offset by a fall in Velocity, leaving national income little changed.

It is also the case that bank reserves are a necessary condition for loan growth but not a sufficient one , as the ECB has found in recent years. Firms and households may not be wiling or able to take on fresh debt and banks may also be constrained by low profitability and capital issues, leaving monetary policy essentially pushing on a string..We have also pointed out in previous blogs that the huge fiscal stimulus seen in response to the pandemic is not funded by monetary creation, at least to date, and will ultimately be paid for by taxapayers, albeit at a borrowing cost kept low by central bank purchases of government debt.

In a world of globalisation and largely free trade any excess demand for goods in a given country can anyway be met by higher imports, with little or no impact on the price level. On that view a generalised rise in inflation across the globe requires the elimination of excess supply at a global level and as central banks have discovered this makes it extremely difficult to achieve a desired level of inflation with monetary measures alone. The pandemic has ceratinly impacted supply but it is not clear there will be a significant long term impact on global capacity. Absent that, the structural factors that have kept consumer inflation low may well continue to work. Asset prices are different, though, in that excess demand there can and does lead to inflation, because supply is constrained, such as land and housing in a given country or equities via buybacks. So liquidity can certainly drive asset price inflation , if not consumer prices.

Irish GDP falls 6.1% in q2 but consensus for 2020 will be revised up.

Irish GDP contracted in q2, as universally expected, but the 6.1% quarterly fall was not as severe as many predicted, although the first quarter is now also seen to have contracted, by 2.1%, instead of the initial 1.2% rise. On an annual basis GDP fell by 3.0% in q2 but this followed a 5.7% rise in the first quarter, leaving the average annual change over the first half of the year in positive territory, at 1.4%. The economy probably grew again in q3 and forecasts of contractions in the 8%-10% range over the full year now look far too pessimistic, with the consensus likely to move higher. Indeed our own forecast of -3.5% looks a tad low and we will revisit the forecast again, although with the caveat that the path of the virus remains the key uncertainty.

We have consistently emphasisied that Ireland’s GDP is largely dependent on exports and that the composition of that sector ( heavily weighted to Pharma, medical devices, organic chemicals and ICT) renders it far more resilient than both domestic spending and the export sector in most other developed economies. Consequently , although exports did fall in q2, the decline was modest compared to the trend elsewhere and left the annual change at zero, following a 6.5% rise in q1, which means that the substantial annual fall in exports envisaged by most forecasters is unlikely to materialise.

The Lockdown did have a significant impact on domestic spending of course, with personal consumption plunging by some 20% in the quarter, taking the annual fall to 22%. Spending on Building and Construction also collapsed, by an annual 35%, with a similar fall in residential construction. The other components of investment ( spending on machinery and equipment plus intangibles) also fell precipitously, by 75%, leaving total capital formation 71% below its level a year earlier. The only spending component of domestic demand to grow was government consumption, with an annual increase of 12%, a big acceleration from the 3% recorded in the first quarter.

The plunge in domestic demand was also reflected in Irish imports, with an annual fall of 37% in the second quarter. Imports are strongly affected by the capital spend from multinantionals, with most of the Intangibles component captured as a service import and as such GDP neutral, although adding huge volatility to the investment and domestic demand figures as well as the balance of payments.

The overall picture them is one in which domestic spending plummeted as a result of the pandemic and the lockdown but with an offset fom the export sector. The latter is what differentiates Ireland from its EU peers and is likely to ensure that the GDP fall here is much less severe than elsewhere, if indeed it falls at all.

Negative Rates Forever

The ECB seeks to set short term interest rates in the Euro Area via control over the amount of liquidity it supplies to the banking system, as the latter is required to observe a minimum reserve requirement, in turn related to the amount of customer deposits each bank holds. The current requirement is around €140bn in aggregate and currently banks have €3,000bn deposited with the ECB, implying excess liquidity of some €2,900bn. This will generally put downward presure on money market rates but there is a floor, in theory at least, which is the ECB’s Deposit rate, which has been in negative territory for over six years now . It was cut to -0.5% last September and if money market rates fell below that banks could borrow in the market and deposit back to the ECB at -0.5%, so this potential arbitrage will generally keep rates above the Deposit rate.

The scale of excess liquidity is such that rates are very close to that floor, nonetheless, with 3 -month euribor trading at -0.486% in recent days. Indeed one money market reference rate, the euro short term rate or €STR, is trading below the Deposit rate ( at -0.54%) because it includes non-bank borrowers, unlike the conventional euribor rates.

How long will these rates last? That ultimately depends on the ECB’s perception of the inflation outlook, but judging by expectations in the money market it will be years before we see a return to positive short term rates- the market is currently pricing in a 3 month rate of -0.125% in six years time. That may not transpire of course but as it stands it implies that rates are expected to be in negative territory for well over a decade, and not the short time period envisaged by the ECB when when embarking on that policy.

Does it matter? The standard ECB argument is that negative rates are just an extension of low rates and will eventually boost credit growth, economic activity and inflation. However, negative rates have put pressure on EA bank profitability in that they have indeed helped push down borrowing costs for households and businesses but , to date, at least, most banks have been reluctant to cut deposit rates for households by a similar amount, which would take them below zero. The ECB argues that this hit to bank margins can be offset by loan growth but negative rates send a signal to potential borrowers , implying a pretty dismal economic outlook and one not conducive to productive investment spending by the private sector. Of course if one also factors in the impact of the Covid pandemic it is difficult to see an explosion in credit growth any time soon.Not surprising , then, that EA banks trade well below their equivalents in the US in terms of equity valuation, with Irish banks at around 20% of their net asset value.

There are other issues, which will become increasinly pressing if negative rates are here for the long term. The ECB can provide liquidity but can’t direct where that goes and it may simply be used to bid up existing assets such as equities and real estate. Negative rates are also a massive challenge to the long established investment model of pension funds and wealth managers. That model envisaged say a 60-40 split betwen equities ( deemed higher risk) and bonds and cash but what happens to that model when the yield on the lower risk asset is actually negative ( as is the case with many EA government bonds) and where large deposits with a bank can be charged a negative rate. In other words a fund will lose money by holding cash in a bank or by lending it to the Government. This leads to the TINA (There Is No Alternative) case for taking more investment risk so pushing up equity valuations, real estate prices and lowering the yield on high risk corporate debt.

It is hard to see how the ECB can get out of the current situation, although it does seem reluctant to cut the deposit rate again, and the implicaions of negative rates for savers are not palatable. Commercial banks may well start to cut deposit rates into negative territory for household deposits with significant implications for high savings economies such as Ireland, where household deposits and currency exceeds debt by €21bn, and where deposits in Irish headquartered banks are €37bn higher than loans. The cost of borrowing for households is low, of course, and in Ireland that mainly flows into property but that is constrained by mortgage controls, which do not apply to institutional investors..

Irish Unemployment: 131,000 or over 1 million?

Unemployment in Ireland is officially measured in the quarterly Labour Force Survey(LFS), based on a sample of households, and the numbers in that category have to be both available for work and to be actively seeking it. The Survey also captures total employment, with the sum of those in work and unemployed defined as the labour force.

Prior to the Covid Pandemic and Economic Lockdown the unemployment figure had fallen to a 115,000-120,000 range, with the unemployment rate hitting a cycle low of 4.7% in late 2019. The first quarter of 2020 saw a modest tick up, to 123,000 , and an unemployment rate of 5%, with the universal belief that the following months would see a massive spike , a view reflected in most economic forecasts, which envisaged average unemployment rates of 15%-20% over the year.

The CSO issues a monthly estimate of unemployment, which is often revised based on the LFS when published, and it was a surprise to many that the increase in April and May was very modest ( a rise to 138,000) followed by a fall in June, to 131,000, with the unemployment rate easing back to 5.3% from 5.6%. On the face of it then, these figures are wildly at odds with consensus forecasts.

The CSO does provide an alternative measure, which takes account of those in receipt of the Pandemic Unemployment Payment, and that figure rose to a peak of around 600,000 in early May. However, those recipients do not meet the definition of unemployed as per the LFS so are not captured in the official figure. One option is to assume all are in fact unemployed ( which is unlikely to be the case)and so adding them to the official figure. The CSO use that approach to give an ‘upper bound’ for unemployment , resulting in a total of 695,000 in April and an unemployment rate of 28%.

The numbers in receipt of the PUP have fallen steadily over the past two months, as Lockdown eased, so the upper bound unemployment total in June had fallen to 560,000, with an unemployment rate of 22.5%. Two competing forces will impact that figure from here- the PUP figure will continue to fall as the economy re-opens but some firms wil either not emerge from Lockdown or do so with a reduced workforce, so boosting the official unemployment total.

The Live Register adds an additonal twist . This measures those claiming unemployment Benefit and Assistance and although not the official measure of unemployment ( the cycle low there was 182,000) the trend is used by the CSO to estimate the monthly unemployment figure . Again the Register picked up sharply in April and May ( to 226,000) but fell back again in June, to 221,000. When the PUP figure is added that total rises to 660,000, None of these figures take acount of those on a Wage subsidy scheme , numbering 382,000 in June, so if they are also added we arrrive at a grand total 1,041,822, with a peak of over 1,250,000 in April.

It is highly unlikely that everyone on a wage subsidy and in receipt of the PUP will end up unemployed so the 1 million figure is hopefully not reflective of things to come. At the other end of the scale it is not plausible that all will resume employment as before, so the official unemployment data may well start to tick up over the second half of the year. Nonetheless, estimates of the official unemployment rate for the year now look far too high , and it also may well be the case that unemployment on that definition will keep rising well into 2021, which again is contrary to the consensus .