Irish GDP grows at average annual 5.5% in H1.

The available labour data shows that Irish employment continued to grow very strongly in the first quarter of the year (by an annual 3.5%) and the decline in the unemployment rate since implies that  pattern is still intact. One would expect GDP growth to be stronger, given normal productivity growth, and although the Irish quarterly GDP figures are extremely volatile, the picture from the National Accounts  is  broadly consistent with the employment data; annual GDP growth in q2 was 5.8%, following a 5.2% rise in q1, to give an average for the first half of the year of 5.5%.The figure for the full year is likely to be lower, given the surge in reported GDP in the latter part of 2016, and we expect around 4%.

On a quarterly basis GDP expanded by 1.4% following a revised 3.5% contraction in q1. The latter reflected a plunge in investment spending, mainly related to mulinational R&D , and that reversed in q2, duly accounting for most of the rise in GDP. Consumer spending actually fell, by 1.1%, and on the published national accounts consumer spending is now only 34% of GDP and only marginally ahead of capital spending- in most developed economies the former is well above 50%.

The CSO now publishes a separate figure , Modified Domestic Demand, to give a better picture of underlying spending and output in the Irish economy, as it strips out multinational flows into R&D and aircraft leasing . On that metric real demand grew by an annual 4.2% in q2 following a 5.8% rise in q1, so the average increase over H1 is  still a very healthy 5.2%, indicating that the underlying economic performance remains strong. One puzzle is  limp  consumer spending, averaging growth of  just 1.8%, which is modest given the strength of employment growth alongside 2% growth in pay. and zero inflation. Domestic investment spending is expanding at a robust pace, in contrast, with annual growth averaging 15% over the first half of the year, albeit hiding a mixed performance, with buoyant construction offsetting a  fall in domestic spending on machinery and equipment.

Overall, it would seem that the Irish economy continues to expand at a robust pace, if one discounts the extraordinary short-term volatility and adjusts for the distortions caused by the sheer scale of the multinational flows.

Irish economy contracts sharply in Q1 but annual growth still 6.1%

According to the CSO the Irish economy, as measured by real seasonally adjusted GDP, contracted by 2.6% in the first quarter of 2017. This still left the annual increase in GDP at 6.1%, however, following substantial revisions to the quarterly pattern in 2016, with growth of 3% in q3 and a bumper 5.8% in q4. The impact on  annual growth  for 2016 was only marginal ( now 5.1% from 5.2%) but the CSO revised up nominal GDP over recent years by significant amounts; the 2016 figure is now €275bn, a full €10bn above the previous estimate and a massive €100bn above GDP in 2012.

This is the denominator used to measure the various debt and deficit ratios incorporated into the Euro zone’s  fiscal rules, and means that Ireland’s debt ratio last year is now 72.8% as opposed to over 75%, with every likelihood of a 70% reading in 2017. Yet many have argued that a better measure of domestic economic activity is required, given the extraordinary influence on the national accounts of the mulitinational sector. Personal consumption is now only 35% of GDP, for example, and is only €9bn higher than Investment spending, 32% of GDP. To that end the CSO, for the first time, have published a modified national income figure. This takes GNP ( which is lower than GDP as it adjusts  for net  cross border income outflows such as profits and interest payments) and deducts the profits of domicilled multinationals as well as adjusting for R&D spending on imports. This gave a figure of €189bn in 2016, compared with a €275bn GDP reading, and a debt ratio of 106%. However, it is clear that the economy has still being growing strongly in nominal terms on the new measure , by 9.4% last year and by 42% since 2012.

Investment spending tends to be the most volatile component of GDP and this was indeed the case in the first quarter, declining by 38% and hence accounting for  the contraction in GDP. Building and Construction rose ( by 5.8%) but this was swamped by a 22% decline in machinery and equipment investment and a 56% plunge in intangibles ( the term for spending on R&D, patents, etc). Virtually all of the latter is imported so service imports also fell sharply ( by over 10%), with total imports down by over 12%. Exports were broadly flat and government consumption barely grew ( 0.3%) leaving consumer spending as the only GDP component showing any positive momemtum, rising by 1.2%. This is still soft relative to retail sales, implying much weaker spending on services, at least as estimated by the CSO. and this divergence has been a feature over recent years.

Where does this leave this year’s annual forecast for GDP growth? The Department of Finance  expect 4.3%  but  the base effects for the second half of the year are now much more negative, albeit against an  annual figure in q1 above 6%. Our own existing forecast is less than 4% and we will produce an update in the next week or so.

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.

Irish labour data another indicator of capacity issues.

Ireland’s GDP, the international standard for measuring economic activity, may cause puzzlement to many and amusement to a few but it is difficult to argue with the labour market data as provided in the Quarterly Household Survey, and that continues to point to a buoyant economy. Indeed, it supports our view that Ireland is currently facing capacity constraints on many fronts,  stemming from years of under investment coupled with very strong growth in the population – the latter has risen by half a million over the last decade and double that in less than twenty years, a fact perhaps obscured by the emphasis in some quarters on emigration alone.

Employment bottomed in the autumn of 2012 on a seasonally adjusted basis  and has since risen by 212,000 . The numbers in work grew by an annual 65,000 in the fourth quarter of 2016, or by 3.3% , with the gains spread across all economic sectors. The Labour force is also growing again, albeit modestly, rising by an annual 25.000, with the result that unemployment fell by an annual  40,000 in Q4, taking the total to under 150,000  for the first time since mid-2008.

The unemployment rate peaked at 15.1%  a full five years ago, and  has been falling since , with the pace of decline accelerating of late,  from 7.9% in August to 6.9% in December, while January has now been revised to 6.8%. It is difficult to say what unemployment rate is consistent with full employment ( the rate fell below 5% during the last boom) but it is now likely that some sectors are experiencing labour shortages. Experience in other countries with low unemployment rates ( notably the US and the UK)  suggests that we may not see a generalised accleration in wage growth , although sectoral differences are already apparent.

The tightening labour market is another indicator of the constraints existing in the economy, as evidenced by the shortage of housing, overcrowded hospitals and clogged roads. Yet official policy appears to remain focused on attracting FDI at all times, irrespective of whether the economy can absorb such flows.

Savers Have Feelings Too

It is a curious fact that following any rate change by the ECB the headlines in Ireland always focus on the impact for mortgage holders. Curious , because there will also be an impact on deposit rates and there are far more savers than borrowers. Indeed, that is now also true for the the sums of money involved; Irish household deposits in the Irish banking sector amounted to €97bn in December, against €88bn in loans to Irish households, a divergence that began to open up from last July.

About three -quarters of these deposits are defined as ‘overnight deposits’ and the interest rate is just 0.12%. This  is a gross figure, and the DIRT rate payable is currently 39% , reduced from 41%, so savers only receive 0.07% i.e. next to nothing. Rates are historically low across the developed world,  of course, but the Government is adding to the squeeze on savers, leaving aside the DIRT issue; the Bank Levy,  which raises €150m a year from Irish banks, is based on the amount of DIRT collected by each institution, and as such provides a disincentive for banks to pay for deposits, particularly as the overall loan to deposit ratio for Irish headquartered banks has been below 100% for some months now. Banks can also access four-year cash from the ECB at a zero interest rate, so have even less reason to seek out deposits. A Levy based on bank profits might have a less distortionate effect on the savings market.

At its core the banking system merely transfers money from savers to borrowers, with the margin received for this intermediation dependent on the degree of competition in the market. That relationship  is often forgotten , with so much emphasis on borrowers, an emphasis not readily observable in other countries.

Irish Household deleveraging may be over

The last few years have seen some recovery in new mortgage lending in Ireland, although  it has not been strong enough to offset debt repayments, with the result that the outstanding stock of household debt has been falling now for almost seven years. That may be about to change, however, reflecting stronger growth in new lending.

New loans for house purchase have been on an upward trend over recent years, albeit from a very low base, but  actually fell by an annual 9% in the first quarter of 2016 , to well under 5,000,  no doubt impacted by the Central Bank’s mortgage controls, before returning to growth again  in the following months, with the final quarter showing a 12% annual rise, to 7,600. This brought the full year  figure to 24,891, or 5.2% above the 2015 total. To put this in context, the cycle low was around 11,000 in 2011, with the cycle high in 2006  at over 110,000.

The average new mortgage for house purchase also rose in 2016, by 6.8% to just under €200,000 , bringing the value of new lending  for house purchase to €5bn. First Time Buyers accounted for just over half that total, with most of the remainder down to Movers, as Buy to Let lending is still extermely low, at just €159m. On the non-purchase side,Top-up loans are also around €160m, albeit rising strongly in percentage terms, as is remortgaging, which increased by 80% to over €500m. The latter figure is less than a tenth of  the sums recorded at the peak of the boom but the pick up implies a stronger degree of competition in the mortgage market.

In sum, then, total mortgage lending ( including top-ups and remortgaging)   amounted to €5.7bn in 2016, or €900m more than the previous year and the strongest reading since 2009. Moreover, the pace of growth is accelerating, with the fourth quarter of 2016 at €1.8bn, a 26% annual increase. We expect this pattern to continue. with  new lending set  to rise to €7.2bn in 2017, driven by double digit growth in house prices, a rise in new housing supply and greater leverage as a result of the Central Bank’s decison to ease mortgage controls.

New lending on that scale may well be enough to offset ongoing mortgage debt repayments, particularly as the final three months of 2016 showed flat net  lending , although the annual change was still negative, at -1.4%. Non-mortgage lending to households has already turned positive again, reflecting PCP funding of new cars, so on a further recovery in new mortgage lending  Ireland  in 2017 could experience the first growth in net  household debt since 2009.

 

Irish Q3 GDP: Volatility again to the Fore

The Irish economy grew rapidly in  the third quarter, expanding by a seasonally adjusted 4% according to the CSO, following a 2.1% contraction in q1 and a 0.7% expansion in q2. This boosted the annual growth rate in q3 to 6.9%, and took the average over the first three quarters of the year to 4.6%, implying that in the absence of big revisions or a very weak final quarter, growth for 2016 as a whole may come in above the current  consensus of around 4%.

Large quarterly swings are far from unusual however, given the impact of multinational trade and investment flows on the headline data and the expenditure components. Imports, for example, fell by 8.6% in the quarter and are down 6% year over year, partly but not solely due to a collapse in investment spending on intangibles (R&D). On the export side , modest growth of 1.7% was recorded in the quarter, so net exports boosted quarterly GDP by an extraordinary 10 percentage points. Merchandise exports, as captured in monthly trade flows, amounted to €29bn yet the figure quoted in the national accounts is some €45bn, with the difference reflecting offshore production from Irish registered firms. This is consistent with internationally accepted Balance of Payments (BoP) practice but it is impossible to predict these ‘additional’ exports, which have ranged of late from €15bn to €24bn per quarter.

Most of the R&D spending is captured as an imported service ( via payment of royalties  by multinationals or for the use of patents) so Q3 also saw a huge fall in spending on intangibles, of 61%, which followed a 124% rise in q2.  Yes, 124%. As a result total capital formation fell by 18% in the third quarter, despite a 30% rise in spending on machinery and equipment (itself distorted by airplane leasing) and another steady increase in building and construction (4.6%).

The  large fall in overall investment spending offset modest gains in personal consumption (0.7%) and government spending (0.8%) with the result that final domestic demand fell by 5.6%, so all the growth in the quarter came from net exports and a strong stock build ( which added 1% to GDP) although large statistical adjustments mean that the component contributions rarely sum to the headline growth figure.

So on the face of it the economy is booming, with GDP up a real 6.9% over the past 12 months. Indeed, if we use GNP as our measure ( this adjusts for income flows in and out of the economy) the growth rate is even more startling, at 10.2%, with the BoP surplus in q3 rising to €10bn, or almost 15% of GDP. Moreover, the CSO has also revised up nominal GDP , so the large falls recorded  earlier in the GDP deflator are now less pronounced.

Yet, some important measures of dometic spending are less robust. Personal consumption, for example, is surprisingly soft, given the strength of the labour market, showing annual growth of 2.1% in q3 and just 0.4% in the last six months. GDP is the internationally accepted measure of growth in the economy but it is clearly giving a distorted picture of underlying activity in Ireland.

 

 

 

Cyclical Mortgage Controls might be better

The Irish Central Bank surprised many people, not least the Government I suspect,  by announcing changes to their macroprudential mortgage rules. The Bank had called for submissions on the controls , and received a good number, including one from this writer , but the rhetoric from Dame Street did not indicate a great appetite for change. In the event the Governor announced what was termed  ‘refinements to improve effectiveness’. Lenders have been granted  more discretion, in that 20% of total lending to non First Time Buyers (FTB) can be above the 80% Loan to Value (LTV)  ceiling , a change from the previous 15% discretionary figure, while FTB’s can now borrow up to 90% LTV , regardless of the price of the property (that limit was previously capped at €220,000). Moreover, up to 5% of lending to FTB’s can be above 90% LTV.

The Loan to Income (LTI) ceilings were unchanged, at 3.5,  and of course the LTV limits are just that; banks are not compelled to adjust their existing loan standards. Indeed, a recent Central Bank analysis of mortgage lending over the first half of 2016 showed that lenders were not fully utilising their available discretion to exceed either the LTI or LTV rules.

These changes also come in the wake of the Government’s Help to Buy scheme, which allowed FTB’s claim back income tax ( to a maximum of €20,000) to be used towards the deposit on a newly built home. One wonders if that subsidy would have been introduced had the new rules been in existence, as the combination of the two certainly provides a massive boost to FTB’s buying power in the property market. Take a couple with a combined income of €75,000,   borrowing €250,000 . Prior to the new rules they would have had to save €35,000 in order to buy a property worth €285,000,  perhaps taking four or five years. Now they could increase their loan to €256,500 (still inside the LTI limit)  and only have to find €8,500  as a deposit if the property was a new build ( a 10% deposit of €28,500 less the €20,000 from the Help to Buy scheme) implying it would take a far shorter time to amass that sum. Alternatively, all or part of their original savings could now be used to buy a more expensive house. In effect, purchasing power has been brought forward and leverage increased.

Credit appears to be driving only about half of current transactions in residential property but given the existing supply issues the boost to FTB’s buying power may well have some impact on price, although that is the mechanism which will eventually lead to a bigger supply response, albeit with a time lag.

The controls are designed to ‘enhance the resilience of both borrowers and the banking sector’ but are actually pro-cyclical; an 80% LTV still means the average size of a new mortgage will rise at the same pace as house prices ( for example, at a house price of €200,000 the mortgage would be €160,000  but rise to  €240,000 if house prices rose to €300,000). A cyclically adjusted LTV might be more appropriate, as put forward in our submission to the Central Bank. When house prices are low and credit growth weak, for example, the LTV limit might be 85% or 90%, but then decline as prices and credit growth pick up, to perhaps 75% or 70% at the top of the cycle. This would not eliminate cyclicality, but would dampen it, particularly if the LTI limits were also flexible over the cycle.

One obvious issue with this proposal is that the Central Bank would have to decide where we are in the credit and house price cycles. However, they currently have to do that anyway, at least in terms of credit; under new capital rules, some banks have to set aside additional capital ( counter-cyclical buffers) in good times in order to cushion losses in bad, and the Irish Central Bank sets this buffer every quarter, in part dependent on the current credit/GDP ratio relative to the long term trend. The buffer is currently set a  zero, reflecting the fact that credit is still contracting and the ratio to GDP is very low.

In addition, the Bank has a number of models that monitor residential prices relative to fundamentals. Deciding whether house prices are overvalued is not an exact science (  as it happens most models point to undervaluation , if anything, at this time) but if a number of indicators were to flash red the Bank could lower the LTV and LTI limits if a cyclically adjusted regime was in effect.

One final point. Research at the ECB supports the case that a debt service limit is more effective  in protecting borrowers and lenders than other macroprudential controls, as again outlined in our submission, although at the moment the absence of a credit register is a key impediment to implementation.

 

Irish Q2 GDP; Deflation re-emerges.

Irish real  GDP contracted in the first quarter, by 2.1%, and the latest CSO data shows a modest  0.6% recovery in q2. Nominal GDP fell however, by 1.0%, which followed a 5.6% decline in the first quarter. Consequently, the consensus forecast for nominal GDP in 2016 is probably too high as indeed are forecasts for real growth of 4.9% and the coming weeks are likely to see some downward revisions.

Consumer spending was weak in the second quarter, declining by 0.5% in volume terms, and  business spending on machinery and equipment also fell, by over 10%. Exports, too, declined, albeit marginally. This broad weakness was offset by a 5% rise in construction and a surge in spending on R&D ( including patents and licences) which is classed under ‘intangibles’ . The latter component is extraordinarily volatile and actually more than doubled in the quarter alone ( +113%) , and as such  was the main factor behind the 39% rise in total investment spending. These intangibles are largely multinational and often purchased from parent companies abroad, so imports also rose strongly in the quarter, by 12%. There was also a postive stock build, adding 1.3% to GDP, although the sum of the components imply that real GDP actually fell, with a large statistical adjustment accounting for the positive growth figure.

On an annual basis real growth in q2 emerged at 4%, and the first quarter figure was revised up to 3.9% so giving an average for the half year also around 4%. Real GDP rose by 5.5% in the final two quarters of 2015 and that  base effect implies that annual growth may slow substantially in the second half of 2016, with the average for the year likely to be well below the 4.9% assumed by the Government.

Similarly, the nominal level of GDP in 2016 is also likely to be lower than anticipated, largely because export prices are falling . Consequently, nominal GDP only grew by an annual 0.5% in q2 , which followed a 1.5% rise in q1. On that basis nominal GDP may be largely unchanged in 2016 or indeed may even decline, with implications for the debt and deficit ratios.

Overall, a mixed bag. The real economy avoided recession , which was a risk given falls in retail sales and industrial production in q2, but deflation has re-emerged, via export prices.

Irish unemployment rises despite strong employment growth

The latest data on the Irish labour market, from the Quarterly National Household Survey  (QNHS) in q2, shows that employment is stronger than generally thought, but that the labour force is also growing rapidly again, boosted by a return to net immigration, with the result that the numbers unemployed actually rose marginally, keeping the unemployment rate unchanged over the first half of the year.

Employment has been growing steadily now for some time and the second quarter saw an acceleration, with the numbers at work rising by a seasonally adjusted 20,000, following a 16,000 rise in q1.  That increase brought the annual rise to 56,000, or 2.9%, and the seasonally adjusted employment figure above two million for the first time since early 2009. Over the past year most industries have created jobs, notably construction ( 11,000) and manufacturing (9,000), although there was some  modest job losses in financial services and (surprisingly)  professional and scientific services.

The labour force in Ireland contracted sharply during the recession and has been slow to recover, although that now appears to be changing, with a 22,000 rise in q2, bringing the annual increase to some 33,000. The participation rate has picked up but a big factor in Ireland’s case is migration. We now know from the 2016 census that net emigration since 2011 was much lower than thought, and   the CSO’s latest estimates  show a return to net immigration in the year to April 2016. Emigration is still high , at 76,000, but immigation has picked up, to 79,000, giving a net 3k inflow. Most immigrants are still from outside the EU (32,000) but the past year has seen a rise in  returning Irish migrants, with a 10,000 increase to 21,000.

The CSO publishes a monthly unemployment figure which is often revised following the QNHS release, and that is indeed the case on this occasion. The unemployment rate has been revised down in q2, to 8.4% from 8.7%, but that is now unchanged from the first quarter, with the numbers unemployed now revised up. Indeed, the unemployment figure in the second quarter, at 183,000, is  actually 1500 higher than in q1.

Overall, the figures indicate that the economy is in better shape than indicated by the first quarter GDP figure ( which showed a contraction) and that household incomes are being supported by strong employment growth. Yet they also highlight an issue we have consistently  flagged of late- the growing signs of significant capacity constraints. Migration has turned positive again, population growth has picked up and the labour market has tightened,  putting pressure on existing resources in housing, health , education and  the infrastructure. There is a clear case then for additional government spending in these areas, particularly when the cost of borrowing is so low, yet existing fiscal rules mean that the State’s room for manoevre is limited.