Irish mortgage lending picking up but still far from healthy market

New  Irish mortgage lending for house purchase peaked in 2006 at some €28bn, with over 110k mortgages drawn down, and subsequently fell, collapsing completely from 2008 onwards before bottoming out in 2011 with a value figure of just €2.1bn and a volume total of 11k. The ending of mortgage tax relief in 2012 prompted borrowers to bring forward their draw down which helped to boost lending to €2.5bn  in that year but the corollary was a weaker figure in 2013, with the value of lending slipping to €2.4bn alongside a fall in volume from the 14k  seen the previous year. Lending has picked up substantially this year, however, and the annual total may well rise to around €3bn, with perhaps over 16k new mortgages for house purchase likely to be  drawn down.

The past year has certainly seen some positive changes in terms of both the supply of credit and the demand for mortgages. The number of active lenders fell away sharply in the downturn and is still low but credit standards are back to more normal levels , having tightened considerably at the onset of the recession ( credit standards always tend to be pro-cyclical). On the demand side affordability is back to the benign levels seen in the latter part of the  1990’s and employment is rising which has helped to support household incomes,  the main driver of mortgage demand. Price expectations ,too, play a part, and  few now doubt that the market has bottomed, at least in the main cities, particularly the capital.

The latest  new lending figures from the Irish Banking Federation (IBF) show that 4337 mortgages for house purchase were drawn down in the second quarter, an increase of 52% on the same period last year and compared with 3126 in the first quarter. Buy-to-let mortgages account for less than 5% of the total compared with a quarter at the peak of the boom, although the rental yield is now higher than the mortgage rate which was certainly not the case in 2006 and 2007. First -time buyers now dominate, accounting for  well over half the total (from a third at the peak) with the balance made up by those moving house, a segment that has taken a much more stable proportion of lending.

The average new mortgage for house purchase is also rising, as one might expect given the rise in house prices nationally, increasing by over 5% at an annual rate in the second quarter, to just over €178k. As a result the total value of mortgage lending for house purchase in q2 was €773m or 60% up on the previous year, following a figure of €539m in the first quarter.

These annual growth figures are clearly very impressive but when put in context the housing market is still far from what might be considered  liquid and healthy. Total transactions amounted to over 8700 in the second quarter, for example, according to the Property Price Register , so the mortgage data implies that less than half of transactions are being funded by bank credit, which remains unusually low. In addition, mortgage repayments are still outpacing new lending so net mortgage lending is still contracting; net lending fell by a total of €1.5bn in the first six months of 2014, which implies repayments of €2.8bn given that new lending (as per the IBF data) was €1.3bn.

What level of mortgage lending would take place in a healthy market?. One approach is to assume that a 3%-4%  annual turnover in housing transactions is normal, implying transactions of 60k-80k (there are approximately 2m houses in Ireland)  compared with around 30k last year, Again, perhaps 80%-85% might be normally funded via a mortgage so that gives a mortgage volume figure in the region of say 50k-60k per annum. The 2014 outturn may well be around 16k so we are still a long way away from an equilibrium, although lending is clearly now finally  moving in the right direction.

Trend in Irish household income rising but savings ratio also increasing

The initially reported contraction in Irish GDP last year has now been revised away which alongside strong growth in the first quarter of 2014 has prompted forecasters to revise up their projections for the full year, with exports and investment spending seen as the main drivers. Consumer spending continues to disappoint, however, having fallen in q1 and the final quarter of 2013, so again dashing hopes of a recovery in that key component of domestic demand. The consensus still expects some growth in consumption this year, nonetheless, but the scale of any forecast  rise is being trimmed back. Consumption largely depends on the trend in disposable income but  the proportion of any given  income spent and saved  can and does vary over time. On that basis the recent trend in disposable income is encouraging but  the  trend in the savings ratio has also started to rise again, reversing the  downward path evident since 2010, adding a further degree of uncertainty to the economic outlook.

Household spending is not uniform through the year and so the savings ratio also exhibits pronounced quarterly swings, falling sharply in the final quarter of the year, for example, and rising steeply in the first quarter. The CSO seasonally adjust for such moves and the adjusted figures for household disposable income and savings tend to be the focus of attention. Volatility is still high, however; disposable income fell by 4.8% in the first quarter of 2014, latest figures show,  after a 3.8% rise in the final three months of 2013, but the change in consumption was  much less pronounced (too modest quarterly declines) so the savings ratio fell sharply, from 15.4% to 11.7%.The implication is that households had to spend a higher proportion of their income in q1 to support spending in the face of a sharp fall in income.

The trend in these variables is more significant, however, and a 4-quarter total shows a different  picture. The latest CSO figures now show that the declining trend in household disposable income bottomed in the first quarter of 2013 and the past year has seen an upturn in income, no doubt supported by the recovery in employment which is offsetting stagnant wages; the 4-quarter income  figure in q1 was €90bn, the highest since late 2010 and compared with a cycle low of €87bn. A modest increase, leaving incomes well below the cycle peak of €102bn, but a welcome change in trend from the relentless falls seen since 2008.

The onset of the recession at that time and accompanying surge in employment prompted a substantial change in household behaviour. The trend in the savings ratio ( defined here as a 4-quarter moving average)  rose sharply, from under 7% in 2007 to over 16% by the end of 2009.Most forecasters  then expected the ratio to decline, particularly when the labour market stared to improve, and that duly unfolded, with a fall to around 10% by the end of 2012. That trend decline has come to a halt, however, with a pronounced upward drift of late, to 12.8% in q1 2014,, the highest since 2010.Households are still deleveraging, of course, and that is no doubt an influence, but household wealth is also rising again and the interest rate paid on savings products is unusually low, which might argue for a fall in the ratio.

I have noted elsewhere that the savings  and income data are subject to substantial revisions  , so the past year’s data may look different in time, but for the moment the trend in  disposable income is positive although it appears households remain cautious about spending, despite other data showing  that consumer confidence has recovered to pre-recession levels.


Buoyant UK economy double boost for Ireland, but rates there may rise soon

The UK economy is growing at a pace which is not only rapid but also well ahead of that generally expected at the turn of the year, prompting a scramble from analysts to revise up economic projections and a reassessment by the market on the likely timing of the first interest rate increase, which is now seen early next year or even before the end of 2014.The unexpected strength of economic activity has also left the Bank of England’s monetary policy strategy is disarray, as it had sought to guide rate expectations with reference to the unemployment rate , with a pledge to keep rates unchanged until the former fell below 7%, which to the Bank did not seem likely till 2016. The unemployment rate is now 6.5% and the Bank  has changed stance, rendering its initial foray into forward guidance somewhat of a embarrassment. None of the nine members of the MPC, which sets the BoE’s policy rate, has yet to vote for a rate increase but it may not be long before we see some advocating tighter monetary policy, particularly as house prices are also rising at a heady clip.

The UK economy experienced a severe recession from early 2008 ,as did most developed economies, although the loss of output was smaller than that recorded in Ireland (7.2% against over 12%) and the duration shorter (5 quarters versus Ireland’s 8). The  UK recovery was also much slower than seen in the past, with falling construction and industrial production offsetting an early rebound in services. All sectors are now growing again and GDP in the UK has risen for 5 consecutive quarters, with the last four seeing remarkably steady growth of 0.7% to 0.8%. That left the annual rise in GDP at 3% in the first quarter and the level of output just  below the previous peak so if q2 growth emerges as expected (around 0.8%) real GDP will have marked a fresh high ( Ireland, by comparison,  is still some 5% adrift of the 2007 peak). Moreover, the UK data has yet to be revised to incorporate the new 2010 standard for national accounts, which will no doubt lead to upward revisions to the level of GDP.

The strong pace of growth has had a significant impact on the labour market; employment rose by almost 1 million, or 3.1%, in the past twelve months, taking the employment rate to a record high, while the unemployment rate has tumbled to 6.5%. That support for household incomes has helped to boost consumer spending (which has risen for 10 consecutive quarters) while business investment has also picked up sharply and is growing at a double digit pace. The external sector is not contributing to growth but otherwise one might say the economy  is booming, although few in the UK would use that phrase. One key reason for that is the absence of any significant growth in pay (indeed annual wage inflation was just 0.4% in May) which has prompted cries of a ‘cost of living crisis’ as inflation, although lower of late, has consistently exceeded the 2% official target. Household incomes as a whole have risen ( given the rise in employment) but real incomes have been squeezed and the increase in consumption has been financed through a fall in the savings ratio, which is now under 5% from a 8% in 2012.

Fiscal policy has also been a drag on the economy in general (although not in 2014) with steeper cuts in government spending earmarked for the next few years, while credit growth , although picking up, remains limp by normal standards. Those factors may have an impact on the BoE’s thinking but it is currently wrestling with the issue of how much spare capacity there is in the economy. Most in the MPC  believe it is still around 1% but there is disagreement , with the persistence of weak productivity adding to the uncertainty about the economy’s  potential growth rate. Moreover, asset prices in general have risen and house prices nationally are increasing at a double digit pace and have scaled new heights, with London clearly in boom territory. Central banks now generally believe that they can prick housing bubbles with macro-prudential tools and the UK authorities have already sought to affect mortgage lending but other  argue that a higher cost of borrowing is the most foolproof safeguard.

Stronger growth in the UK have proved a double boost for the Irish economy. Some 16% of  total Irish merchandise exports go to  the UK (the share of services is higher at around 19%)   but it is  a much more significant market for Irish indigenous firms, taking over 36% of food exports , for example. and so growth there is a boon for Irish firms. In addition, the prospect of higher rates has led to an appreciation in sterling, with the euro rate falling to 79 pence, again a welcome support for Irish firms selling into the UK market, although to put that in historical context that  would be parity in terms of the punt/ sterling, hardly a rate seen as very advantageous for Ireland. Nevertheless, sterling’s relative strength is positive for Ireland and the UK currency may have further to rise given the differing outlooks for monetary  policy in the UK and the euro area.

€10.7bn boost to Irish GDP improves Budget outlook

I recently questioned the timing of calls for a strict €2bn fiscal adjustment in the 2015 Budget (‘Irish Fiscal Adjustment-too soon to know‘, in part based on the simple observation that the first quarter GDP data had yet to be published, with the additional caveat that the CSO figures would incorporate substantial revisions to previous data, reflecting the adoption of a new international standard of accounts. The figures have duly emerged and were a major surprise, both in terms of past revisions and in relation to growth in the first quarter of the year.

The level of Irish GDP  has been revised back to 1995 and is now substantially higher than previously published; the 2013  figure was initially estimated at  €164.1bn but is now put at €174.8bn, in large part due to the inclusion of R&D spending as investment (some illegal activities are also now estimated). The revision might be seen as just a statistical quirk in the arcane world of national accounts but it has an important implication- Ireland’s debt and deficit ratios are now lower than previously thought. The debt ratio in 2013, for example, was over 123% but is now 116.1% thanks to the higher GDP denominator. The annual deficits are also affected but the impact is less dramatic ; the 2013 deficit falls to 6.7% from the initial 7.2%.

The revisions to GDP did not have a huge impact on real growth rates, although last year’s marginal contraction in the economy (0.3%) is now seen as a modest gain of 0.2%. Growth did pick up sharply in the first quarter of 2014, with real GDP expanding by 2.7%, thanks to a strong contribution from net exports and to a substantial rise in inventories. GDP had fallen sharply in the first quarter of 2013 so that also dropped out of the annual comparison, leaving real GDP 4.1% above the level a year earlier. Consequently, the consensus growth figure for 2014 as a whole ( currently around 2%) is likely to be revised up , probably to well over 3%.

In fact the data revisions also incorporated reclassifications to external trade, with the result that exports and imports are  also now higher than previously published. The broader picture of an export-led recovery has not changed as a result however, with domestic demand still contracting over six consecutive years from 2008 to 2013. Indeed, the positive news on first quarter growth must be balanced against another  decline in domestic spending with all three components recording falls. Consumer spending is up marginally on an annual basis, albeit by only 0.2%, and at this juncture the 1.8% rise forecast by the Department of Finance looks unachievable, with deleveraging proving a stubborn offset to the positive impact of employment growth on household incomes.

Export prices are falling, as is the deflator of government spending, so the annual rise in nominal GDP in q1 was not as strong as the volume increase. emerging at 2.8%. Nonetheless it seems reasonable to assume a 3% or so rise in nominal GDP for 2014 as a whole which would yield a figure around €180bn, or a full €12bn higher than recently assumed by the Department of Finance, and result in a deficit ratio of 4.4% instead of the 4.8% currently projected, assuming the actual deficit emerges on target.

For 2015, the Department forecast a 3.6% rise in nominal GDP , to over €174bn, but on the same growth rate the implied level of GDP is  now over €186bn, given the higher starting point..As things stand the 2015 deficit is projected at €5.1bn, predicated on a €2bn adjustment, but that would now deliver a deficit ratio of 2.7% of GDP and as such well inside the 3% limit imposed under the excessive deficit procedure.Of course the deficit may diverge from expectations over the second half of the year and GDP may disappoint (including revisions!) but at this point the news today from the CSO is clearly positive for the economy and the Budget outlook, with the implication that a €2bn adjustment may not be required if a 3% deficit remains the target.

Ireland’s fiscal adjustment-too soon to know

Ireland’s 2015 Budget is four months away but the debate about the scale of fiscal adjustment required has intensified, with contributions from the IMF, the Irish Fiscal Advisory Council, the Minister for Finance and  other assorted politicians. Some argue for the €2bn figure  set out some time ago while others claim that  a lower figure will suffice. In truth it is far too early to be definitive as there is a high degree of uncertainty , both about the fiscal outlook and prospects for the Irish economy, and given this lack of clarity it is puzzling that so many can take a dogmatic position.

Ireland’s total fiscal adjustment since 2008 amounts to some €30bn, and was required to keep the fiscal deficit on a declining path with a target for the latter of under 3% of GDP by the end of 2015. So the adjustment in any given Budget, be it cuts to government spending or measures to raise additional revenue, is a residual with the size determined by the forecast deficit ratio in the absence of any new policy measures. Note that the target is not the actual deficit itself but the deficit relative to GDP, so there are two areas of uncertainty, one relating to the performance of the economy and the other to the evolution of exchequer spending and receipts, although the latter is of course strongly influenced by the pace of economic activity. Inevitably, the actual deficit and the level of GDP will diverge from that forecast, making any projected adjustment less meaningful, particularly into the medium term. Yet in recent years the forecast Irish fiscal adjustment figure has become  a target in itself, rather than the residual. Some claim that sticking to an announced adjustment enhances credibility, which seems to be the IMF view, although it is not clear why a figure projected a few years earlier must be adhered to even if circumstances have changed, and given that such adjustments will dampen economic activity.There is also a temptation for the government to ‘spin’ the Budget presentation in order to be seen to ‘achieve’ the  previously announced adjustment.

Take the 2013 Budget. The  adjustment figure ahead of time was seen as €3.5bn and according to the  pre-Budget Estimates  the 2013 fiscal deficit would be €15bn, or 8.9% of forecast GDP , on unchanged policy.The deficit target was set at 7.5% of GDP, with an actual deficit of  €12.7bn, and the government duly proclaimed an adjustment of €3.5bn, even though the measures announced on Budget day amounted to €2.8bn, with the remainder mainly due to ‘carryover’ effects from previous spending and revenue decisions. In the event the deficit came in almost €1bn below forecast, at €11.8bn, thanks to a significant overestimation of debt interest  and higher non-tax receipts than projected, including profit from the Central Bank. However, real GDP actually contracted in 2013 instead of growing as expected and nominal GDP emerged €3.6bn lower than forecast, so the deficit ratio came in only marginally below target, at 7.2% of GDP, despite the much better than projected outturn in the deficit itself.

The 2014 Budget projected a deficit of €9.8bn in the absence of any adjustments, or 5.8% of forecast GDP. Consequently, policy measures were required to hit the deficit target , announced at 4.8% of GDP, with an adjustment figure of around €3.0bn widely discussed. Indeed, that was the figure announced by the Minister ( actually €3.1bn ) although the measures introduced on the day amounted to just €1.9bn, with the residual due to the familiar ‘carryovers’ and  previously unidentified ‘resources’ on the expenditure side , including ‘savings’ and lower debt interest. So the €3bn ‘adjustment’ was anything but, although the announced measures are forecast to reduce the deficit to €8.2bn, or 4.8% of GDP.

Five months into the year  the authorities are confident that the deficit figure will be achieved and  tax receipts are running 2.9% ahead of profile, which may persuade the Department of Finance to revise up their tax projections for 2015, hence implying a lower deficit figure before any adjustments. It is early days yet, however, as we do not  even know how Ireland’s GDP performed in the first quarter- retail sales have picked up at the headline level but the value of merchandise exports actually fell on an annual basis in q1 thanks to a decline in price, which will dampen nominal GDP. Uncertainty over the latter is also compounded by the change to a new standard for national accounts (ESA 2010) which will count R&D as capital spending for the first time,  and this along with other minor changes may boost the level of Irish GDP  by 2% or more and so impact the deficit ratio, albeit marginally.

So it is by no means clear at this stage what adjustment will be required to meet a 3% deficit target next year, be it  lower or indeed a higher figure. Austerity fatigue has set in across many European countries and the IMF call to maintain a previously forecast adjustment can be seen in that light, but any adjustment involves serious economic and social costs and  is a means to an end rather than an end in itself.




ECB Traversing outer limits of Policy

The ECB has travelled a long way in its thinking over the last few years, and following the latest round of measures is now at the outer limits of monetary policy, with little left in its armoury. Indeed, we may be moving closer to the point where European policy makers decide that putting all the pressure on monetary policy is a mistake, and that fiscal policy has to be more active when faced with a balance sheet recession and its aftermath.

Inflation in the euro area has been below the ECB’s 2% target for some time and Draghi has often emphasized the fragile nature of the limp economic recovery but the past month has seen a much more negative perspective emerge, as crystallised in the Bank’s economic projections; growth is expected to remain below 2% for the next three years and inflation is forecast to rise to just 1.4% in 2016 from 0.7% this year. Deflation is not seen as likely but such a prolonged period of low inflation is seen to carry  the risk that expectations of sub-2% inflation become embedded.

The ECB can only directly influence very short term interest rates ( the market determines longer rates) and Europe depends heavily on bank credit to finance private sector spending ( as opposed to bond financing) so any policy levers are largely dependent on the banking sector as the transmission mechanism, with the added complication that lending rates are much higher in some parts of the zone than others. The Bank tried to address that fragmentation by providing 3-year cash to the banks in late 2011 but over half of that has been repaid and many banks used it to fund the purchase of government debt, with the result that bank lending to non-financial corporations in the euro area is still contracting. That is due in part to the economic cycle ( demand for loans is low) but the ECB has copied the Bank of England’s  Funding for Lending scheme in seeking to influence the supply of credit  via the  provision of  funds aimed directly at the private sector. Under the targeted scheme (TLTRO)   euro area banks can access funds for up to four years, starting in September, at an initial rate of 0.25%, with an initial limit of some €400bn (7% of the outstanding loan stock ex mortgages) implying a figure in excess of €5.5bn for Irish banks given the €78bn outstanding in loans to non-financial firms (the figure could be higher if one includes personal debt ex mortgages). Draghi talked about monitoring the loans but at first site the penalty for not lending to the private sector is early repayment so it is not clear how much of a stick exists alongside the carrot. Further tranches can be drawn down depending on meeting benchmark targets on net credit growth.

The UK scheme did not have a huge impact and  it remains to be seen whether demand for loans will pick up particularly in depressed economies. Banks are also due to repay some €500bn of the remaining 3-year funding although the ECB has also decided to stop sterilizing the bonds purchased under the SMP, meaning it will no longer drain the equivalent amount of money from the system. The buying of private sector debt, via Asset Backed Securities, is also on the cards, although that will take some time to organise and the market there is small.

As noted the ECB can directly affect short rates and it cut the main refinancing rate by 10 basis points to 0.15%, which  will bring some modest gains to anyone on  a tracker loan and to banks borrowing from the ECB. Lower rates may also put some downward pressure on the currency on the FX markets and to aid in that the ECB cut its deposit rate to negative territory (-0.1%) and will supply as much short term liquidity as banks demand at a fixed rate out till the end of 2016. This puts some flesh on the pledge to keep rates at current levels for an extended period and seeks to influence longer term rates in the market. The euro had weakened in the weeks before the ECB meeting in early June as traders built up  short positions in anticipation of negative rates, but has not fallen further, at least as yet, highlighting that measures that are seen to reduce fragmentation in the euro area often serve to bolster the currency.

The forward guidance issued by the ECB also now excludes any reference to even lower rates and Draghi explicitly stated that we are at the end of the line in terms of rate reductions. Consequently, the  main weapon the ECB has left is full QE, but that is unlikely to have much affect on euro domestic demand given the importance of banking credit. Hence the TLTRO but if that does not work ( and it will take some time anyway for any impact to be felt) the conclusion has to be that fiscal policy may be revisited, with the current conventional wisdom on the need for debt reduction overturned in favour of fiscal expansion. That may be a long shot now but who would have predicted  a few year ago an ECB Funding for Lending scheme, forward guidance and a refinancing rate of 0.15%?


Irish Household incomes and pay

The plunge in support for the sitting Government in the local and European elections has been attributed to a number of factors but a general theme is the view that Irish households are not seeing any improvement in their incomes, despite the much talked about economic recovery. Irish GDP has indeed picked up somewhat but the increase has been very modest, at just over 2% from the low in late 2009 , and extremely uneven, with any quarterly gains often followed by contractions, as per the most recent figures for the final quarter of 2013.The labour market has been an unambiguous positive, with surprisingly strong job creation through last year, but the available data from the CSO  shows that household incomes still fell in 2013, for the fifth year in succession, and that trend is clearly dominating  many people’s perception as to the general health of the economy.

Gross household disposable income in Ireland grew very rapidly in the first half of the noughties, sometimes at a double digit annual pace, and peaked in 2008 at just under €102bn. Wage income is the major driver of total household incomes (the product of average pay and the numbers in employment) and during the boom both components were rising at around 5% per annum, with other gains from rents, profits and rising transfers from the State.  The scale of the fall since then has been extraordinary;gross income is now back under €87bn, a level last seen in mid-2006, following a cumulative 15% fall over the past five years. The plunge in employment has been a key factor, but the other components also fell , offsetting higher transfers, and the tax burden has also risen, although it is worth noting that two thirds of the total €30bn fiscal adjustment occurred between 2009 and 2011.The hit to nominal incomes has been cushioned to some degree by low inflation (in fact negative at times) but the CPI is currently around the same level as in 2008 so that 15% decline translates into a similar fall in real incomes.

The pace of income decline is slowing however, with the initial data showing only a 0.5% fall in 2013, and the latest figures on pay point to some potential improvement. Weekly earnings did fall in the first quarter of 2014 but the  annual decline was a very modest 0.4% and included a 0.7% increase in private sector earnings. The quarterly data can be very volatile but the private sector did record marginal pay increases in both 2012 and 2013 , albeit with a very broad distribution, including strong gains in the  professional and scientific area and in information and communication, with more modest rises in retail alongside further falls in  other industries. The pay increases seen in the first quarter were broadly based,  nonetheless, with 7 of the 10 private sector industry groups recording wage gains, including a double digit annual increase in construction, over 4% in industry and over 5% in the hospitality sector. Pay in the public sector is still falling however and so a significant rise in overall earnings is unlikely this year, but the downward trend may at least be coming to an end.

Any rise in average pay will of course boost household incomes, as will a further increase in employment, although  job creation slowed to a halt in the first quarter and the rise in 2014 is now likely to be lower than most forecasts had envisaged.Rents, too, are rising again, offering further support to household incomes, but disposable incomes will be affected by a rise in tax receipts .Overall, then,the big falls in household incomes are hopefully  behind us but it is difficult to see a period of strong increases in incomes in the near term particularly if employment growth slows further.

Irish Consumer Confidence is a puzzle

Irish consumer confidence , as measured monthly by the ESRI/KBC index,  has risen sharply over the past year and is now back at levels last seen in early 2007,  i.e. before the financial crisis and subsequent plunge in Irish employment and economic activity. The economic situation in Ireland has  certainly improved of late but the scale of the change appears at odds with the buoyant confidence readings and is difficult to explain.

The index is compiled from a telephone survey of households and is based on a number of questions involving the respondents own economic situation and perceptions of the broader economic backdrop. The series is volatile and is best viewed as a three-month moving average and on that basis  over the past  decade  has ranged from over 100  (during 2004 and 2005) to around 40, the low recorded in mid- 2008. Confidence subsequently picked up to a high of 66 in mid-2010 before plunging back below 50 around the bail-out and  entry of the Troika later that year. A slow and uneven recovery ensued but the past twelve months has seen a marked acceleration, with the index currently standing at 85 from around 60 in the spring of last year.

As noted, this is now at levels last seen some seven years ago but the economic backdrop then was very different. The economy was at full employment, for example, with the unemployment rate at 4.5% against 11.7% now, although the latter has fallen from a peak of over 15%. Inflation was much higher back then, at around 5%, as against the current 0.3%, but the Misery index (the sum of the unemployment rate and the inflation rate) was still lower , at 9.6 versus 12 today. Wages were also growing strongly in 2007, by 5% per annum, in contrast to the falls recorded in recent years ,and of course disposable income has also been hit by tax increases since 2008.

The index is thought to have  a close relationship with retail sales and consumer spending but again the picture is very different in the two periods; real personal consumption was growing at an annual rate of some 7% in the first quarter of 2007 but the most recent figure, for the final quarter of 2013, showed a 1.1% fall in consumption. Spending probably turned positive again in the first quarter but most forecasters envisage a 2% rise in 2014 at best,  far from the pace recorded when confidence was  last at similar levels.

It may well be that the index is responding in an exaggerated manner to specific variables, such as the rise in house prices ( which is not positive for everyone), or simply reflecting relief that the economic situation is not as dire as was the case in 2008-2010, and that the economic outlook, although still cloudy, is at least somewhat clearer than  appeared at the worst of the crisis. It is also possible that the consensus is wrong and that spending will surprise to the upside so supporting the confidence index as a useful forward indicator of spending. Time will tell on that issue but it does seem clearer that another observed relationship involving the index has indeed broken down, at least for now- the correlation between consumer confidence and support for the government. In general, strong readings in confidence tended to go hand in hand with strong support for the sitting government, as captured by opinion polls, but that relationship appears to have well and truly splintered of late , as the confidence surge over the past year has not translated into a  boost for the  government in the polls.

QE in the Euro area

Mario Draghi made it clear at  his press conference in early April that the ECB had no qualms about using QE if additional unconventional monetary policies were deemed necessary. The Bank may have come late to the party and asset purchases are not a given but the message has been reiterated over the past few weeks and that possibilty has been instrumental in driving peripheral bond yields in the euro area to levels few expected to see in a short time frame. The ECB is also more openly concerned about the euro’s relative strength  and its implications for the economic outlook  and some see QE as a means to weaken the currency, although the recent performance of the euro implies that not many in the foreign exchange market believe that QE is imminent or that it is negative -indeed traders have opened up speculative long positions in the currency.

In fact the  evidence on QE  elsewhere indicates that it can work through different channels and that it  may not precipitate a currency depreciation. Quantifying the impact of asset purchases is difficult as one can never know how the economy would have performed in its absence and expectations  can also  play an important role  but there are various statistical and econometric methods available which can at least give some approximations. The most recent work on the topic was published in a discussion paper by the Bank of England (‘What are the macroeconomic effects of asset purchases’, Weale and Wieladek, April 2014) comparing the effects of QE on the US and UK economies. The paper finds that QE does indeed have a significant impact on real activity and inflation, with asset purchases equivalent to 1% of GDP having a much bigger impact on real GDP in the US (a rise of 0.38%) than in the UK (0.18%) although a similar impact on inflation ( 0.38% in the US versus 0.3%)

The study also found that QE impacted the respective economies through different channels. The US is far less dependent on bank credit than the UK and longer term interest rates on financial instruments are much more important. Consequently, QE’s impact on longer term bond yields appears to have been the decisive channel in the US. In contrast,  the main impact  in the UK was through shorter term rates, which were  expected to remain lower for longer, and  reduced market volatility. The FX impact also differed; sterling’s real exchange rate was not seen to be affected by QE whereas the dollar did depreciate according to the study.

What are the implications for QE in the euro area?. Well, we know that the market for private sector bonds in Europe is not large so any purchases  by the ECB would probably concentrate on longer term government bonds (hence the rally of late) , although, again, shorter term rates and bank lending probably have a much bigger impact on the euro economy. That suggests that the impact on GDP would be nearer to the UK than the US experience and that  €1000bn in QE (around 10% of euro GDP) would boost GDP by some 1.8%. Inflation in the euro area is much stickier than the US or UK so one doubts if the CPI would rise by the  3% or more indicated by the BoE study. Nor is it  a given that the exchange rate would depreciate-indeed, by lowering the risk premium on peripheral bonds  QE may  actually support the euro.

Of course the ECB may decide to do nothing for a while longer, particularly given the prospect of stronger growth in the euro area in the first quarter, and in a sense the mere  promise of QE may have already achieved at least some of its aims. An actual announcement may  therefore  risk disappointment and lead to some selling of bonds  ( ‘buy the rumour. sell the fact’) . So if the ECB does want a weaker euro, negative interest rates might well prove a better bet  than QE given the mixed results elsewhere.

Irish Austerity Budgets: why more may be needed

The 2014 Irish Budget was the eighth in succession since 2008 (there were two  in 2009) which cut government spending or raised taxes with the total fiscal adjustment amounting to €30bn, including around €11bn in tax measures. These austerity Budgets were undertaken in order to reduce Ireland’s fiscal deficit and  therefore  comply with strictures under the EU excessive deficit procedure , with the State required to reduce the deficit to under 3% of GDP by  the end of 2015( last year’ it was 7.2%). The Troika may have gone but that requirement remains and Ireland, like others in the same predicament, has to produce a Stability Programme Update (SPU) each April, which sets out medium term forecasts for the economy, the fiscal outlook and the debt situation.

The latest SPU, just published, revealed that the  Government expects this year’s cash deficit to emerge €0.9bn below that initially forecast but that the General Government deficit ( the preferred EU budget measure) will still be about €8bn or 4.8% of forecast GDP, as per the original projection. Real growth in the economy is expected to be marginally stronger than envisaged last October , at 2.1%, although the Department of Finance is now much more upbeat about domestic spending, including a 2% rise in personal consumption and a 15% surge in investment spending, and now expects the external sector to have a negative impact on GDP, with export growth of only 2% offset by over 3% growth in imports.

The main change to the outlook relates to inflation, however, with price pressures across the economy now projected to be much weaker following the trend in 2013. Consequently nominal GDP  is now forecast follow a lower trajectory  in the medium term than previously thought; the 2014 forecast is for GDP of €168.4bn instead of the original €170.6bn , with similar shortfalls over the following few years That  change affects the debt dynamics and although the burden is still expected to fall from last year’s 123.7% of GDP the decline is now slower; the 2014 debt ratio is now forecast at 121.4% instead of the original 120%.

The growth forecast also envisages the economy gathering momentum into 2015 and beyond (although previous projections were too optimistic in that regard) and further strong gains in employment, a combination that might imply less need for further austerity measures. The Minister for Finance has signaled otherwise and to understand  why that may be  the case it is  necessary to delve a little deeper into the SPU document. The Irish economy, according to the EU, is actually operating very close to capacity and to full employment, a view which would surprise many and one that has met with some opposition, most recently from the ESRI in its latest ‘Quarterly Economic Commentary’. That debate may seem arcane but, unfortunately, it has serious implications for Irish households because on the EU view the Irish deficit is virtually all structural and therefore will not disappear with stronger growth. The actual deficit will shrink but if one adjusts for the economic cycle the structural deficit would still remain, requiring policy measures to reduce government spending and/or increase tax revenue. Moreover, Ireland is charged with reducing the structural deficit to zero  by 2019 from last year’s 6.2% of GDP, which implies the post-2015 fiscal landscape will not be as sunlit as some expect. A given economy’s position in the economic cycle is not observable and estimates are just that,so convincing the EU that far more of the  Irish deficit is cyclical would have a big impact on the perceived scale of  the fiscal adjustment required.