Irish real GDP now 50% above pre-crash peak

The volatility in Ireland’s quarterly national accounts has always been a feature and has increased of late, given the scale of the multinational influence on the headline data. The third quarter was no exception; real GDP rose by 4.2%, with the annual change at 10.5%,  leaving the average annual growth rate year to date at 7.4%.  Negative base effects would normally imply a marked deceleration in the final quarter ( the economy grew by 5.8% in q4 last year) and on that basis average growth for 2017 as a whole may well be around 6.5%, although given past experience anything is possible.

The  growth surge in q3 occurred despite a 13% plunge in domestic demand. Consumer spending rose at the strongest pace for some time (1.9%) and government consumption expanded by 0.7% but capital formation fell by 36%, with modest growth in construction ( 2%) dwarfed by a 22% fall in spending on machinery and equipment and a 60% decline in outlays on Intangibles. The latter largely comprises spending by multinationals on R&D and is particularly volatile (a 58% increase in the previous quarter) but is offset in the national accounts by service imports. That largely explains why  total imports  fell by 11% in q3, against a 4% increase in exports. Consequently net exports contributed a massive 16 percentage points to q3 GDP growth, which alongside a big stock build offset the negative contribution from investment.

Total merchandise exports exceeded €49bn in the quarter, against under €28bn recorded in the Irish trade data, highlighted the scale of contract or offshore  manufacturing. That export strength and the fall in imports contributed to a massive €14.5bn Balance of Payments surplus in the quarter, over 18% of GDP, with the surplus year to date at over €22bn.

On the headline data, Ireland’s real GDP in q3 is  now 50% above the pre-crash peak ( recorded in the final quarter of 2007) with exports having doubled. Consumer spending is only modestly higher, however, by 4%, while government consumption is still marginally below that previous high. It used to be argued that GNP provided a better guide to national income in Ireland but that too is 47% above the pre-recession level, with re-domicilled multinationals now impacting the amount of profit outflows. To give a better idea of underlying activity  on a quarterly basis the CSO have developed  a modified domestic demand metric, which seeks to exclude multinational R&D flows and the impact of aircraft leasing. On that measure domestic capital spending actually rose, by 5%, as did domestic demand, by 3%.

Annual growth in modified  final domestic demand  was 5.0% in q3, bringing the average over the first three quarters to 4.9%. which is much closer to the consensus GDP growth forecast for the year as well as being similar to the pace of expansion implied by the employment data. Yet, GDP is the standard measure of economic activity  and  barring a massive fall in q4  Ireland is likely to record a much stronger  growth figure  in 2017 than anyone envisaged.

Irish Central Bank tightens mortgage controls

The Central Bank introduced macroprudential controls on Irish mortgage lending in early 2015 with a focus on Loan to Value (LTV) and Loan to Income (LTI). The controls are subject to annual review and were initially amended  in January 2017 with  another set of ‘refinements’ just announced , to take effect from 2018.The latter includes quite a significant modification to the way the LTI control operates and in our view represents a tightening of credit controls, although one does not get that impression from the Central Bank release.

Currently, 20% of Principal Dwelling House (PDH) lending can exceed the 3.5 LTI limit. Data released by the Central Bank  shows that  PDH lending for the first half of 2017 amounted to €2,770m and that €487m exceeded the limit, or 17.6%, indicating that the limit is being observed, at least for that six month period  (  it  actually applies over a  full year).  Yet the data reveals a marked divergence between FTB’s and other buyers; over 24% of lending to the former was in excess of the 3.5 LTI limit, while for the latter the figure was only 10%.

Clearly the LTI limit is a much bigger issue for FTB’s in an environment of scarce  supply, strong house price inflation and where around half of house sales are going to non-mortgage buyers . As the controls currently stand there is no specific constraint on the amount of  FTB lending in excess of the LTI limit , as long as the overall lending figure is within the 20% exemption.

The Central Bank has responded by amending the LTI exemption. From January the overall 20% limit no longer operates, with  a 20% exemption  limit allocated to FTB lending and 10% to other lending. Had these applied over the first half of the year FTB lending would have been €61bn lower, with no material impact on other lending.

Just over half of PDH lending is currently to FTB’s so the implication is that there is now a 15% overall exemption limit in practice, given a 20% allocation to FTB’s and only 10% to other buyers. The Central Bank argues that FTB lending is less risky than to second or subsequent buyers ( although credit agancies seem to have a different view) , so justifying differential LTV’s and now LTI exemptions, but the changes would appear to mask an effective tightening in overall lending standards. The Bank notes that ‘the refinement is not expected to have a significant impact on the functioning of the market’  but it clearly will limit overall exemptions relative to the  current postion.

Irish Misery Index on rise after all-time low

Irish consumer sentiment, as captured by the KBC/ESRI monthly index, reached a record high early in 2016 before slipping back later that year.It has picked up again in recent months and is now close to the previous peak. Households would therefore seem to feel good about the economy and their own financial situation and an alternative measure, the Misery Index, tells a similar story.

That is simply the sum of the unemployment rate and the inflation rate, two readily available monthly indicators that are likely to have a strong impact on the average household. The index fell to around 6 in 2004, reflecting an unemployment rate of 4.5%, and soared to a high of 18 in 2011 amid a collapse in employment.

The steady fall in unemployment in recent years has been the main driver of the decline in the index, which fell to an all-time low in June of 5.7%, with inflation at -0.4% and unemployment at 6.1%.The latter has fallen further, to 6.0%, but inflation has turned modestly positive so the index is now rising again, albeit still at 6.3%.

The Misery index has probably bottomed in this cycle, however, given the likely trend from here in inflation and unemployment. The latter may find it difficult to fall much further as the recent data implies we are at or near full employment; it has taken five months for the unemployment rate to fall from 6.2% to 6.0%.

Inflation may well see the sharpest change. Falling energy  prices and lower mortgage rates were big factors in dampening the CPI over the past three years but energy costs  have now started to rise again on an annual basis and mortgage costs are now unchanged on a year earlier.  The euro’s appreciation against  Sterling has proved a significant  counterweight over the past year, reducing the price of imported goods, notably food, but that will not be repeated absent another lurch down in the UK exchange rate.

Consequently, we may well have already seem the low of the cycle in the Misery index, although the increase may well be at a modest pace.

Population and migration data highlight pressure on resources.

Estimating the Irish population in the years between census counts is tricky. The birth rate is known, as is the death rate, but migration flows are notoriously difficult to measure, so estimates are often revised when the census data is available. That is the case following the 2016 census, with net migration now much lower than previously thought, which also means that the prevailing post-crash narrative has to be revised, along with an acceptance that the economy faces overheating and capacity issues,rather than large scale underutilisation of resources.

That narrative  envisaged very large emigrant flows dwarfing immigration, with a net outflow between 2011 and 2016 of just under 100,000. That figure has been revised down, to 31,000, with net immigration turning positive again in 2015. Immigration estimates for the period have been revised up, by a net 27,000, but the biggest change is on the emigration side, with a downward revision of 40,000.

So fewer people left than generally believed and more entered than initially thought. What about the trend post-census? The CSO estimate that net immigration rose to 20,000 in the year to April 2017, up from 16,000 in 2016, which alongside a natural population increase of 33,000 brought the total numbers in Ireland to 4.79 million. This represents a 1.1% annual increase, following a similar rise the previous year, and on that basis the population will hit 5 million  in another four years, which is  much earlier than the standard official projections.

Pressure on resources has been evident for a number of years now, and these migration and population figures bring some hard evidence on the need for a big increase in Ireland’s economic capacity, in health, education, transport, infrastructure and housing. On the latter, population growth implies the need for a net increase in the housing stock of 22,000 a year, implying a  completions requirement of  32,000 a year ( given obsolesence), just to maintain a constant population/ housing ratio, let alone account for a trend fall in the numbers per household. We are unlikely to hit that annual  figure for another three or four years, implying a very substantial backlog and hence  the need for an overshoot in the annual requirement.

 

 

 

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.