Ireland’s plunging birth rate and rising unemployment challenges narrative on economy

The CSO has just published two significant data sets , one relating to  the latest demographics and the other to the labour market in the second quarter of the year. The former was broadly as expected,  but the latter came as something of a shock, challenging the recent narrative on the economy.

The Irish population has been growing strongly again after a softer period following the financial crash and that trend continued in the twelve months to April, with a 65,000 increase (1.3%) taking the total to a fresh high of 4.92m. In general, official estimates and projections have tended to underestimate population growth, in large part because of the signifcance and volatility  of migration in the Irish data. In this case  the scale of emigration was largely unchanged from the previous year, at 55,000, but  offset by  substantial immigration of some 89,000, again similar to 2018, to give a net migration figure of 34,000. The latter is now larger than the natural increase ( births – deaths) which has slowed significantly  of late, to 31,000 from 49,000 at the turn of the decade. Indeed, the Irish birth rate ( births per 1,000 population)  although still very high by EU standards is falling rapidly , to 12.4 from 16.6 a decade ago.

Nonetheless, the robust pace of overall population growth allied to the boom in economic activity has resulted in  the emergence of massive capacity constraints across many areas of the economy, most nobaly housing but also in education, health care, public transport and the  infrastructure  around the main cities. The current make-up of that population growth ( a falling birth rate offset by  high net immigration ) makes it particularly difficult to plan for the future, however, as a period of weaker growth in Ireland might have a very significant impact on migration flows and hence total population.

The boom in the economy had propelled employment  to record highs and prompted much discussion about the level of full employment, as the unemployment rate had fallen to a cyle low of 4.5% in June. In that context the other main CSO release, the quartely Labour Force Survey, was a shocker. Headline employment fell marginally in q2  from the previous quarter but normally rises for seasonal reasons and so the adjusted figure saw a 21,000 decline, spread over half of the fourteen industry sectors categorised by the CSO. The labour force continued to rise  in the quarter so the numbers unemployed rose, as did the unemployment rate, to 5.2% from 5.1%. A marginal change in that context but it did result in a much more significant revision to the previously published monthly estimates, as unemployment in July is now 18,000 higher than previously thought and has been rising for the past four months, taking the unemployment rate to 5.3% instead of 4.6%.

Coverage of the data tended to emphasis the annual growth in headline employment, which is still impressive at 40,000 or 2.0%, although this is the slowest annual growth rate since early 2013. The seasonal  adjusted fall in q2 also followed a strong rise of 49,000 in q1 giving a net positive figure over the first half of the year of 28,000, so one might put all this down to a quirk in the data ( which is based on a household survey) particularly as the numbers claiming unemployment  benefit are still falling, albeit at a much reduced pace.

However, confidence surveys have weakened of late and some of the hard data has pointed to slower domestic activity, notably retail sales which fell by a cumulative 6.5% in the three months to July. One obvious culprit behind this caution is Brexit, which may also be impacting the demand side of  the  housing market. Indeed one other surprising feature of the Labour Force data was that construction employment has flatlined for the past nine months, which may be due to a scarcity of labour but also to caution from builders and developers as well.

All in all, food for thought- has unemployment bottomed in this cycle or is this just a short term hiccup which a Brexit resolution  might help to cure? On population, the Irish birth rate may still be the highest in Europe but is heading rapidly towards the EU average which is under 10.

Are estimates of Irish housing demand far too high?

The consensus view on Irish housing is that demand exceeds supply by a considerable margin and that the gap is closing, which many conclude is the key factor in the clear deceleration in residential property price inflation seen over the past year. Yet the increase in supply is not that pronounced and it may well be that demand is not as  substantial as generally believed, particularly into the medium term..

The latest figures on housing completions from the CSO, covering the second quarter of the year, show a half- year total of 9,100  which implies the full year figure will be above the 18,000 recorded in 2018,  albeit pointing to a outturn below 21,000. Supply is therefore still rising but at a sluggish pace, and certainly still a long way from the 30,000-35,000 widely seen as a good estimate of the annual demand over the medium term.

That figure is largely based on projections for household formation but there is an obvious circularity in that households are defined as occupying a house or an apartment. In other words  housing supply creates household formation so  the latter is not an independent estimate of demand. For example, the number of  households in Ireland rose by just 48,000 in the five years to the 2016 census, or by less than 10,000 per annum, but the numbers living in those households increased by 166,000, indicating a rise in the average household size. Housing demand projections  generally assume that the size of households will fall over the medium term.

So household formation averaging 30,000 or more a year implicitly assumes  housing supply around that figure , and lower supply would mean lower household formation. A look at the latest population projections by the CSO also gives food for thought. On the assumption of unchanged fertility and an annual net migrant inflow of 30,000 per year the population between 25 and 44 increases by just 8,000 in total by 2025, with the numbers between 30 and 40 years old declining sharply. If migration was much lower, at 10,000 per annum, and fertility declined, the CSO projection shows a 100,000 fall in the 25-44 age group which is the cohort one generally associates with house purchase and household formation.

If supply is the main determinant of demand  the recent data on planning permissions, showing a fall in the annual figure to below 29,000, casts doubt on whether supply will exceed 30,000 a year and , if so , household formation will be much lower than the received wisdom. The average number per household may in fact continue to rise .

 

Strong growth in first quarter following large upward revision to 2018 GDP

The Irish economy, as measued by real GDP, is now deemed to have grown by 8.2% in 2018, as against the initial 6.7% estimate. Growth in 2017 was also revised up, by around 1% to 8.1%, according to the latest National Accounts. The most interesting change came in the personal consumption component, which had seemed puzzlingly soft given the buoyancy of household income. It now transpires that consumption last year was  €107bn, or €3bn higher than the initial estimate, and real  consumption growth over the past three  years is now put at 12% instead of 8.8%, Government consumption growth, in contrast, was revised down and is now 2% lower than initially recorded over the past three years, albeit still at a robust 11.9%.

GDP in 2018 is now put at €324bn, some €6bn higher than the initial estimate, which means that the General Government debt ratio is now about one percentage point lower at 63.6%. The CSO also produced the first estimate of modified national incomein 2018, which some prefer to use as the debt denominator, and this came in at €197bn giving a ratio of  104.4%, down from 109.5% in 2017.

Turning to 2019, recent higher frequency data , notably employment and industrial production,  had implied strong GDP growth in the first quarter  and that duly emerged, at 2.4%. Exports and personal consumption both grew by around 1%, with government consumption expanding by 0.5%. A strong stock build was also evident but these positives were offset by a 25% plunge in  capital formation,  reflecting similar falls in both spending on machinery and equipment and Intangibles. The latter is largely due to multinational activity and is also captured in the national accounts as a service import, so is GDP neutral (imports fell by 2.8%) but of more significance was the underlying decline in machinery and equipment spending when adjusted for aircraft leasing, meaning that modifed capital formation ( designed to better capture domestic investment) actually fell by 2.4%.

The first quarter advance  boosted the annual growth rate  of GDP to  6.3% and the  consensus for the full year is under 4% (our own estimate is 5%). However, analysts may in general hold fire on any material changes to forecasts given the evident weakness  over recent months in the UK and EA economies, alongside softer growth in the US. Brexit remains the biggest specific risk, of course, and the fall in domestic business investment may well reflect the uncertainty about  the shape  and timing of an eventual resolution.

Irish economy grew by 6.7% in 2018 but slowed sharply in final quarter.

The Irish economy, as measured by real GDP, grew by 6.7% in 2018 following a 7.2% rise the previous year. The outcome was marginally ahead of our 6.5% estimate but below consensus, with many expecting a figure around 7.5%. Nominal GDP grew by  8.3% and is now €318bn , or €150bn (88%) above the pre-crash level, which flatters ratios using GDP as the deflator, such as the debt ratio, which fell to below 65% in 2018 from a peak of 120% in 2012.

That surge in GDP  largely reflects the growth of investment and exports, and it is striking that personal consumption now only accounts for one-third of Irish GDP, indicating that it has far less influence on economic growth than the norm elsewhere. Consumption, as recorded in the national accounts, has also been surprisingly modest given the strong rise in household income seen in recent years;  the former grew by  4.4% last year or 3% excluding price changes, which implies a significant increase in the savings ratio given that household disposable income probably rose  by at least 5.5%.

In fact government consumption has outpaced personal consumption for the past three years, with a very strong real rise of 6.4% in 2018 bringing the  volume increase since 2015 to  14.5%.Clearly the government has taken the opportunity afforded by better than expected tax receipts, largely from corporation tax, to increase current  as well as capital spending at a robust pace.

Building and construction has been expanding strongly since 2013 and the rise in 2018 was 15.9%, similar to the previous year, with housebuilding up 26%, although the pace of growth is slowing, as one might expect given the low base for house completions post-crash and subsequent high growth rates in percentage terms.

Spending on machinery and equipment tends to be volatile in general but in Ireland’s case is strongly affected by the purchase of aircraft, with the latter particularly strong last year, contributing to a 37% increase. The other component of capital spending is Intangibles, covering R&D, and this fell, by over 10%, albeit recovering strongly in the second half of the year. The net result was that total capital formation rose by 10% in 2018 after slumping by over 30% the previous year.

Virtually all of the Intangibles spending is also recorded as a service import and total imports grew by 7% in real terms last year, albeit outpaced by an 8.9% increase in exports. giving a positive contribution from the external sector. Indeed, the current account surplus on the balance of payments rose to €29bn  or 9.1% of GDP from €25bn in 2017.

Looking at the quarterly data, a marked deceleration through the year is apparent,  with the annual growth rate slowing from 9.6% in the first quarter to 3% in q4,  the latter implying a softer carry-over into 2019 than many had expected.The slowdown was particularly evident in consumer spending and construction. In fact the quarterly change in GDP in Q4 was just 0.1% and modified domestic demand (which seeks to strip out multinational investment spending) actually fell marginally.  It is also noteworthy that unemployment actually ticked  higher in the final months of 2018 and that house prices fell in three consecutive months to January. Brexit uncertainty is no doubt a factor but it may be that the economy is approaching  or even at full employment and hence supply contrained as well as suffering from a short period of softer demand.

Has Irish Unemployment hit its cycle low?

During the Celtic Tiger years the Irish unemployment rate was consistently below 5% and most forecasters envisage a return to  that position in 2019. The monthly data had put the January figure at 5.3% and although the pace of decline had slowed it seemed reasonable to assume that the strength of job creation would be sufficient to  again  push the unemployment rate below 5%, before hitting full employment.

That view  is now open to question, following the release of the latest Labour Force Survey, covering the final quarter of 2018. Figures for employment, the labour force and the numbers unemployed are derived from that survey, based on a sample of households, and it is often the case that the published monthly unemployment estimates are then revised. That is again the case; the q4 average unemployment rate  is now put at 5.7% from the previous 5.4%, with the January figure  also revised up to 5.7%.

In fact  it now transpires  that the unemployment rate is unchanged at 5.7% for the past six months, with the actual numbers unemployed some 10,000 higher in January than previously thought. Indeed, seasonally adjusted unemployment, now at 137.000, has been ticking up for the past five months, so the prospect of a sub-5% unemployment rate  suddenly looks optimistic rather than realistic.

Why is the unemployment rate becalmed? A decline requires  employment growth to outpace that of the labour force which has been the case since early 2012. For example, the annual change in employment in q4 was 50,000 or 2.3%, against a 35,000 (1.5%) increase in the labour force, resulting in a fall in the unadjusted unemployment rate to 5.4% from 6.1% a year earlier.

The pace of employment growth slowed in the second half of last year, however;  the seasonally adjusted increase was only 8,300 in the final quarter, following a 9,500 increase in q3. Labour force growth over that period was 20,000 , so giving rise to the modest tick up in  the numbers unemployed and an unchanged unemployment rate.

Where to from here? A key driver of any change in the labour force is the participation rate ( the proportion of those  over-15 in the workforce).The Irish participation rate ticked up in response to brighter employment prospects but has been broadly unchanged now for some time, at around 62%. If that  continues the labour force will grow at the same pace as the over-15 population, currently at 1.5%, implying an annual rise of around 35,000. Unfortunately, employment growth, having slowed in the second half of 2018, is now  down to that 1.5% pace.

Brexit related uncertainty may be a factor on the employment side but it could well be that the  decline in Irish unemployment is  already at or near its cyclical low.

Ireland now a nation of savers, not borrowers

Much has changed in Ireland over the past decade and one of the most striking in economic terms is the  tranformation in Irish households from borrowers to savers although much of the coverage in the media  still concentrates on credit and the cost of new loans and so does not reflect this new reality. Ireland has morphed into Germany and we are now closer to Berlin than Boston.

Irish household borrowing peaked over ten years ago, in mid 2008, at €204bn, and most of this debt had been used to purchase residential property , which of course at the time had soared in value over a long period, leaving households with net worth of over €700bn. By 2012 the latter figure had collapsed to under €450bn, largely reflecting the 50% fall in house prices, but debt was also declining, given little or no new borrowing and the ongoing repayment of mortgages.

Indeed, household debt is still falling, at least on the figures to the third quarter of 2018 as published by the Central Bank, to €137bn , a reduction of €67bn from the peak.  Household income is growing strongly again and so the debt/ income ratio, a standard measure of the debt burden , is now down at 126% , a level last seen in 2003. Rising house prices and  the recovery in equity markets in recent years has boosted wealth, leaving net worth well above the previous peak, at €769bn.

Interest rates are historically low ( the average rate on new  mortgage loans is around 3%)  and wealth is at record levels so one might imagine that households would be reducing savings and increasing debt but that is not the case. New mortgage lending  has certainly picked up, reaching €8.7bn in 2018 as a whole, but that was largely offset by redemptions, leaving the net change in mortgage credit  on the balance sheet of Irish  banks at only €1.1bn. A rise nonetheless, but that is not inconsistent with the overall data on household debt, as that relates to the third quarter and includes money owed on mortgages no longer on the balance sheet of the original lender.

Central Bank controls now limit the degree of leverage allowed in the mortgage market and the relatively limited supply of new housing is also a contraint  so we are unlikely to see an explosion in household borrowing, even in an environment with less economic uncertainty. However, the savings side of the balance sheet is also witnessing a profound change, with a huge increase in the amount of wealth held in cash and deposits; the q3 figure was € 143bn , a €15bn increase in the past three years. So Irish households now hold more in cash and deposits than they owe in outstanding loans (€137bn), quite a change,  and this  has also had a major effect on Irish headquarterd banks, as they are now in effect Credit Unions, with loans amounting to only 93% of total deposits.

The returns on these deposits are also extraordinarily low of course, amounting to an average of 0.29% for outstanding deposits (the euro average is 0.3%) and a meagre 0.04% on new term deposits ( euro average 0.3%). Monetary policy is based on the notion that the economy responds to a change in interest rates, and that a substantial decline in rates will boost credit growth and encourage savers to spend and borrow. That certainly has not been the case in Ireland and so it is not clear what the impact of higher rates will be on what is now a net savings economy, if and when that day arrives. As it stands that  day seems far off, with the market not priced for an ECB rate rise till around June 2020, although that can and will change with the flow of economic events.

Irish Growth slows to 4.9% in q3: 6.5% average still likely for 2018

The pace of Irish economic growth slowed sharply in the third quarter, with the annual increase in real GDP easing to 4.9% from 8.7% in the second quarter and 9.0% in q1. This reflected  downward revisons to growth in the first half of the year and a modest 0.9% increase in GDP in q3 and in our view means that the average growth rate for the year as a whole is likely to  be close to our 6.5% estimate.

Consumer spending rose by 1.0% in the quarter although the annual change slowed to under 3%, which is consistent with a degree of caution from households;  cash deposits are rising strongly and the savings ratio is also moving higher.In contrast, government consumption is roaring ahead, rising by an annual 6.1% in q3, as is Building and Construction, with annual growth of over 18%.  Against that, spending on machinery and equipment fell  when adjusted  for the impact of aircraft leasing, so the growth in modified domestic demand, which many use as a proxy for underlying growth in the economy , slowed to 4.1% from 6.0% in q2.

GDP measures total spending on machinery and equipment  of course, and that virtually doubled in q3 relative to the previous year, reflecting a 215% rise in transport equipment, largely aircraft. Spending by multinationals on Intangibles ( R&D) is also extremely volatile and that too went up sharply on an annual basis in the quarter, by 34%, so reversing a declining trend of late. As a consequence total capital formation rose by over 43%, breaking a six quarter trend decline.

That fall had also resulted in weak imports but that too reversed in the third quarter, with an annual increase of 16%, subtantially exceeding the otherwise strong  export growth of over 9%. So on the aggregate data , domestic demand made a very strong contribution to overall growth, offset by a negative contribution from the external sector.

As noted, we retain our 6.5% estimate for GDP growth in 2018  based on the assumption of a further slowing in the annual rate in the final quarter, which also implies a weaker base for 2019.

Irish economy grew by annual 9% in q2 following 9.3% in first quarter.

Having contracted by 0.4% in the first quarter Irish real GDP grew by 2.5% in q2, bringing the annual growth rate to 9.0%, following a 9.3% rise in q1. The implication is that is that the consensus forecast for the year as a whole ( 5.4% on Focus Economics) is too low and indeed our own projection of 6.5% may need revising, although the annual growth rate is likely to slow appreciably in the second half of the year given strong base effects.

One surprising feature of  GDP in recent years is the modest growth recorded in consumer spending, given the pace of employment and income growth. That appears to be changing however, with the annual increase in  real consumption accelerating to 4.4% in the second quarter. Government consumption is also growing strongly, at 4.2%, as is building and construction, up over 13% , driven by a 38% surge in house building. Spending on machinery and equipment excluding aircraft leasing rose by 26% so overall capital formation by the domestic economy rose by 13%, which when added to personal and government consumption gives a 6.2% rise in modified domestic demand, following a similar increase in q1.

Some prefer this concept as a better measure of real activity in the Irish economy but  GDP as a whole is the international standard, which means taking account of aircraft leasing, spending by multinationals on R&D and intellectual property (Intangibles), and of course exports and imports.   Intangibles are notoriously volatile and this was indeed the case in q2, with an annual decline of 63%, with the result that total capital formation actually fell very sharply, by  32%, giving a very different picture than the domestic investment data would imply about investment spending in Ireland.

Most of this Intangible spending is also captured as a service import, and as a result overall imports fell by an annual 6.0%, in contrast to an 11.3% increase in exports. So when account is taken of these largely multinational related activities net exports contributed some 20 percentage points to annual GDP growth, offset by an over 10 percentage points contraction from capital spending.

This contribution approach is particularly problematical when one looks at the quarterly change in real GDP. Here, the net export contribution was 6.8 points, which when added to a strong stock build and a modest rise in dometic demand implies the economy grew by 8.3% in the quarter. The reported figure of only 2.5% reflects  a very large statistical adjustment of  -€2.4bn

Irish economy contracts in Q1 but annual growth increases to 9.1%

The Irish economy contacted in the first quarter of 2018 according to preliminary data from the CSO. Real GDP declined by 0.6% , largely due to a sharp  5.8% fall in exports, including both goods and services. Trade data  indicated that exports leaving Ireland had risen substantially so the weaker figure was due to a fall in contract manufacturing (offshore exports credited to Irish based firms).  Final domestic demand was broadly flat, with modest increases in investment (0.6%) and government spending (0.4%) offsetting a 0.3% contraction in consumer spending. Surprisingly, perhaps, construction spending actually fell, by 0.4%, but this was offset by a 9% rise in spending on machinery and equipment. The big negative contribution from exports was in contrast to a very large stock build which added over 3 percentage points to GDP growth.

Looking at the annual change, real GDP growth in q1 was 9.1%, largely driven by the external sector ( export growth of 6.1% against a 1.1% fall in imports) and the strong stock build. The weakness in imports partly reflected a fall in investment spending of 3.8%, with growth in construction and machinery and equipment offset by a plunge in R&D expenditure, which largely relates to multinationals and deemed a service import.

The CSO release incorporated revisons to past data, including  reductions in the level of GDP; the 2017 figure is now  some €2bn lower at €294bn. Real growth last year is also now lower, at 7.2% versus an initial 7.8%. Last year’s quarterly figures have also changed, although the previously published pattern- weak growth in the first half of the year followed by a surge in the second half- is still intact. That  still implies that the anual growth rate will slow as the rest of the year unfolds, which of course is required if the consensus growth figure of around 5.5% is achieved.

The revisions also impacted Modified National Income, the concept developed by the CSO to adjust GDP for the effect of multinationals on profits, R&D expenditure and aircraft leasing. The 2016 figure is now put at €176bn, from an initial €189bn, with the 2017 estimate at €181bn, or less than 62% of published GDP. The CSO believes that this modified figure is a better indicator of Irish income although in 2017 it grew by just 3% and that is in nominal terms, which sits uneasily with other indicators such as  the growth in employment , tax receipts and household incomes .

Full Employment in Ireland-are we there yet?

The Irish unemployment rate fell to a fresh cycle low of 5.1% in June, from 5.6% in March and 6.6% a year earlier. The monthly estimate is subject to revision but on the face of it implies that  employment growth has accelerated from an already strong pace and that Ireland is approaching full employment. The  speed of the decline has  certainly surprised most analysts; the Department of Finance   anticipated unemployment bottoming out next year at 5.3% from an average 5.8% in 2018. In fact, Government budgetary projections are predicated on the view that the economy is already operating above is potential, although one rarely hears that articulated by Ministers.

Full employment does not mean a zero unemployment rate; there will always be churn in the labour market (frictional unemployment) and some workers may not have the skills, education or aptitude to take up the available jobs (structural unemployment). The scale of the latter, in particualr, is hard to gauge so estimates of what unemployment rate is consistent with full employment often vary and can change over time; the unemployment rate has surprised to the downside of late in both the US and the UK, for example. Ireland has also experienced  lower unemployment in the past, with a rate under 4% in the early noughties and a sub 5% reading  in the years before the 2008 crash.

That perhaps argues that the unemployment rate could certainly fall further, and particularly as the participation rate ( that proportion of the population over 15 in the labour force) is still much lower than it was a decade ago, averaging 62% over the past year as against well over 66% in 2007. A return to the latter level would equate to an additional 170,000 joining the labour force, equivalent to three years  employment growth given the current pace of job gains.

That kind of a move in the participation rate seems highly unlikely, however, given the modest level of net immigration currently seen relative to the pre-crash period. Nonetheless, the pool of available labour is bigger than captured in the labour force data, as the figures also record those who are seeking work , but not immediately, as well as those available for work but not yet seeking it. The CSO defines these two groups as the Potential Additional Labour Force (PALF) and this figure is sizeable, amounting to 120,000 in the first quarter. The unemployment rate adjusted for the PALF is therefore much higher, at 10%, although it is problematical to compare this with the historical experience as there was a step jump following the switch to a new survey methodology in the latter part of 2017.

Employment is now marginally above the pre-crash peak  and if labour is getting scarcer one might expect to see an acceleration in wage growth as firms bid for workers. That has not been evident, however, at least as yet. Average weekly earnings in the private sector rose by an annual  1.8% in the first quarter of 2018 following a 1.7% rise in 2017, but that followed  a 2.3% increase in 2016. Low consumer price inflation may be a factor but wage inflation is surprisingly soft in some areas where there is perceived to be a scarcity premium, notably construction, with average earnings growth of 1.1 % in the first quarter and only  0.3% last year.

It is also worth noting that although total employment is again  around the pre-crash peak  the composition  is more evenly distributed across sectors. Then, 10.5% of jobs were in construction alone but that proportion in 2018 is only 6%, with the total employed some 100,000 below the peak. Employment in industry too is 20,000 below the pre-crash level  and also lower in retail (36,000) and financial services (4,000) Indeed, although some private sector areas have seen job gains, notably Hotels and Restaurants (30,000 ) and Professional and Scientific (12,000), most of the increase has occurred in areas dominatd by the public sector, including Education (30,000) and Health (40,000).

Ultimately, the clearest sign that the economy has reached full employment is when the unemployment rate stops falling and that is only observed ex-post. However, the current distribution of employment, the absence of aggregate pay pressure and the relatively low participation rate all point to the likelihood of unemployment falling further in the absence of a demand shock. The latter is always a risk, of course, be it from Brexit or from a broader global slowdown.