Are current euro sovereign yields irrational?

The Irish Government issued a 15-year bond recently at a yield of 2.49% and the 10-year benchmark is trading at under 1.6%, a far cry from the double digit levels seen in the latter just a few years ago. Sovereign yields across the euro area have plunged of course ; 10-year yields in Italy are down at 2.3%, Spain is trading at 2.1% while Portugal is just over 3%.The perceived risk of default  over the next five years has clearly changed dramatically and judging by Credit Default Spreads is now around 10% for Italy, 17% for Portugal and less than 5% for Ireland.

German yields are lower still and bund yields can be considered the nearest thing to a risk-free rate in the euro area. Consequently, a 10-year bund rate of just 0.8% implies that the market expects short term  euro interest rates to stay low for a long time and then to rise only slowly; the implied 5-year forward yield in five years time is under 1.5%.Interest rates are also extremely low in other currencies but higher than bunds, with the US 10-year yield at 2.34% and the UK  trading at 2.1%. The 5-year forward rates also tell a  very different story- the US implied yield is just over 3% , with the UK at 2.8%.So the bund curve indicates  that investors expect inflation to stay low for a long time and not to threaten the ECB’s 2% target. This , in turn, indicates an expectation that growth will remain weak in Germany, with the prospect of  secular stagnation clearly seen by many investors  as more than just an academic debating point.

That scenario  may or may not materialize but it would appear to be a plausible rationale for the current level of bund yields. The problem is , though, that such a scenario would be very negative for other euro zone economies, particularly those with extremely high debt burdens and needing an internal devaluation to become more competitive within the zone. A prolonged period of very low nominal GDP growth, possibly with price deflation, would severely damage fiscal capacity and via the denominator put further pressure on already stretched debt ratios; Italy’s ratio in q2 of this year  was 134% , for example, with Portugal at 129%.Indeed, Italy’s GDP is already falling steadily and in real terms is back to the level recorded in early 2000.

Buyers of peripheral euro sovereign bonds can point to Draghi’s ‘whatever it takes’ mantra and  it would seem that the market views full-blown QE (i.e. buying sovereign debt)  by the ECB as inevitable and that somehow this will save the day. The Governing Council is clearly split on the issue, however, and some opposed the current plan to buy Asset Backed securities which explains why Draghi is at pains to add the qualification ‘within our mandate’ to his statement that there is unanimous support for additional non-standard policy measures.- clearly some members feel that the ECB could be acting ultra vires. So QE is not inevitable but if it did emerge (through a majority vote perhaps) it is still problematical relative to experience elsewhere. The banking system in Europe  is the main source of credit, unlike the US where the disintermediation of banks is the norm, so QE may not have much impact. Moreover Central banks in the US, the UK and Japan have bought their own sovereign bonds but the ECB has no sovereign bonds to buy- it would have to choose among the sovereign bonds of the 19 member states. How would it proceed if it chose a €1,000bn target- would it buy in proportion to the country weights within the euro area, or target higher yields? The former would imply the purchase of large amounts of  bunds and say only €12bn of Irish bonds. In addition the ECB would be buying at extremely low yields ( elevated prices) so adding a high degree of market risk to the credit risk inherent in QE.

More fundamentally, transferring ownership of some sovereign debt from one group of investors to another (in this case the ECB) does nothing to change the debt burden unless of course one believes that the ECB will effectively tear up the bonds or hold to maturity and then pass the proceeds back to the respective governments. One doubts if that would be acceptable to the Germanic school within the Governing Council, at least on any scale that would make much difference to high debt countries, but such concerns do not seem to weigh much on investors at the moment.

Odd Timing for Proposed Irish Mortage Restrictions

Interest rates are extraordinarily low in many parts of the world; the ECB refinancing rate is 0.05%, in the US the equivalent is less than 0.25% and in the UK the Bank rate is 0.5%.Rates are expected to rise next year in both the UK and the US but the respective central banks have made it clear that any increases are likely to be moderate and that  the cost of borrowing may well settle at levels below previous cyclical highs. In the euro area the economic  outlook is bleaker and most observers expect rates to remain at current levels for a number of years. This low-rate environment carries potential risks for asset bubbles and excessive credit growth so central banks have embraced the idea of macro-prudential tools i.e. measures that can be implemented to protect against systemic financial instability. The housing market is often seen as a specific stability risk and a number of countries have introduced restrictions on mortgage lending, the latest being the UK, where only 15% of new mortgages can be above a Loan to Income (LTI) ratio of 4.5.

The Irish Central bank has now entered  macro-prudential territory with proposals on mortgage lending designed to ‘increase the resilience of the banking and household sectors to financial shocks’ .Like the Bank of England there is a restriction relating to LTI, but in the Irish case the limit is lower , at 3,5, although 20% of lending can be above that limit. In addition, the Bank is also proposing restrictions in terms of loan to value (LTV ) with only 15% of lending allowed above an LTV of 80%. For Buy -to Let loans the LTV limit is 70% with only 10% of lending above that. The LTI restrictions only apply to principal dwelling homes (PDH).

The Bank refers to international evidence supporting the view that LTI restrictions can slow mortgage lending growth and ‘reduce the potential for a housing bubble to emerge‘ although the impact on house prices is less clear, with the Bank of England claiming that there is ‘some evidence of a modest and lagged effect on house price growth’. The latter conclusion is not surprising as credit is only one variable in most house price models, with income, interest rate, the user cost of housing and price expectations also playing important roles. The Central Bank also notes that LTV restrictions are more important after a crash, in limiting losses for the lender.

The proposals have generated debate, of course, with some welcoming the move as important in dampening house price inflation (despite the caveat noted above) while other have argued it will hit  the First Time buyer (FTB) particularly hard and dampen housing supply.Indeed, the LTV limit would appear to be binding now, with 44% of new PDH lending  last year above 80%, while only 7% of lending was above 4.5 LTI, with 77% at 3.5 or below.

Another issue is the timing of the proposals. House prices in Dublin have certainly risen sharply of late and are now over 40% above the cycle low but outside the capital prices have recovered by just 9% and most observers, including the Central Bank and the ESRI, still conclude that prices are not excessive relative to fundamentals such as income or rents. A greater puzzle on timing relates to the credit cycle, given that the restrictions are designed to directly impact lending.The stock of outstanding mortgage debt in Ireland has been falling now for five years and the latest figure, for September, showed a 3.1% annual decline. New mortgage lending for house purchase is picking up but amounted to  just €1.3bn in the first half of 2014 and is still being swamped by redemptions and early repayments. Ireland is therefore hardly swimming in new mortgage lending so restrictions at this time seems premature, particularly as the secondary aim of the moves is to ‘dampen pro-cyclical dynamics between property lending and housing prices’ . That might suggest that restrictions would be better served if actually adjusted for the cycle, with  the LTI limit  reduced if credit growth is deemed too rapid and  the LTV limit reduced if house prices are deemed in excess of fundamentals.

The proposals may indeed dampen  future housing cycles but also have broader societal implications. The Government  was not consulted  and is now reported to be considering some form of mortgage insurance scheme to help FTBs secure a higher LTV.The Governor of the Central Bank in a recent speech also  appeared to be more comfortable  than indicated in the proposal document with the idea of  FTB insurance although with the caveat that who provides the insurance is important. Insurance protects the lender , not the borrower of course, and has to be paid for.A broader conclusion from the Governor’s speech may be that  the proposals will see further modification before implementation, or a longer lead-in time. As it stands the restrictions do have significant implications for  young Irish households, with a longer period of saving in store and therefore a later age for home ownership, at least for some.

Irish petrol prices under downward pressure

Spending on energy accounts for over 10% of the average Irish household budget and the volatility of energy costs is often a significant factor in the swings evident in the  overall inflation rate. The past year has seen a much more stable picture,  however, and in September energy prices were 1.7% below the same month in 2013.  Spending on petrol  and diesel accounts for over half the total energy spend and prices there have also fallen , by some 4% over the past year. The price of petrol at the pump has also eased over the past few months and currently averages around €1.50 a litre, from  €1.57 in July. Further falls are likely in the near term  in the absence of a significant fall in the euro, to perhaps  around €1.47,  given the events unfolding in the oil and gasoline markets.

Tax accounts for around 55% of Irish petrol prices but the recent Budget left fuel alone, following a series of tax increases since 2009, amounting to over 20 cent per litre. Apart from the Exchequer, the price of petrol is largely determined by three factors; the price of crude oil, the value of the euro against the dollar and refinery margins. The global demand for crude is rising but at a slower pace than most expected  -the International Energy Agency has just revised down its forecast for this year and next-reflecting sluggish world growth and a steady decline in the amount of oil required to produce a given unit of output;oil provided 46% of world energy needs in 1973 but only 31% today..The biggest recent  change in the global oil market has come from the supply side, however, with a large increase in non-OPEC production; in the past year non-OPEC supply has increased by over 2 million barrels per day  and in the near term increased production from that source is expected to more than offset any likely increase in overall  global demand. A big factor in that change is the increase in output from the US (in part reflecting the impact of oil from Shale sands) with production there currently challenging Saudi Arabia for the title of largest world producer.

The price of Brent Blend, the European crude benchmark, has fallen by 22% over the past three months, to around $85 a barrel in the face of these demand and supply changes. The euro has also fallen against the dollar over the same period but the decline there has been much  less pronounced, at around 7%, so in euro terms crude oil is now some 15% cheaper than it was in mid-July. In the medium term the price of crude will determine the price of refined products, including petrol, but in the shorter term the margin that a refinery can make  by ‘Cracking’ the barrel of crude (the ‘Crack spread’) can vary, depending on local demand conditions and the degree of excess capacity in the industry. Crack spreads in Europe have been higher in recent months than they were a year ago  but the wholesale price of gasoline has fallen sharply of late and now broadly reflects that of the fall in crude.

A 15% fall in the wholesale price of petrol  over recent months would therefore imply a 7% fall in prices at the pump from the mid July level  (given  over half the price is tax) which would leave average prices around €1.47 a litre. Price will vary around this, of, course, given local supply and demand conditions but most areas should see some price declines, although the demand for petrol is now rising again nationally, which may also influence retail margins. The main risk to that outcome relates to the euro, which has regained some ground of late but still looks vulnerable given the economic backdrop .

 

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Irish Budget could now add up to €1bn in stimulus to economy

In April, the Irish Government expected that another round of tax increases and spending reductions would be required to get the 2015 Budget deficit below the 3% target set by the EU, with €2bn seen as the adjustment figure. That would have taken the cumulative adjustment to €32bn since the initial retrenchment started in 2008 but in the event it now appears that such is the transformed economic outlook that the 2015 Budget ( to be delivered on Tuesday Oct 14) will now provide a stimulus to the economy, which may amount to up to €1bn, depending on how much leeway the Minister for Finance chooses relative to the 3% target.

A key factor behind this remarkable change in the budgetary position is the performance of the economy over the first half of 2014. That has prompted the Department of Finance to revise up its real growth forecast for this year and next; 4.7% growth is now envisaged in 2014, from an initial 2%, with the economy forecast to expand by 3.6% in 2015. Nominal GDP is also now seen as being much higher than originally  projected, with  a figure  of €193bn  forecast by the Department , an extraordinary  €19bn above that forecast six months ago. A stronger economy implies a lower cash deficit, via reduced welfare spending and higher tax receipts, with a higher nominal GDP figure also helping to lower the fiscal and debt ratios.

It has been apparent for some time that this year’s deficit would be much lower than initially forecast and the Government’s ‘Estimates of Receipts and Expenditure’, published last night, predicts a 2014 General Government deficit (GGD) of  €6.9bn, which is €1.2bn below that envisaged in April. The deficit ratio is also much lower, at 3.7% of GDP instead of 4.8%. In fact that outturn, if it materializes, would be a little worse than some had expected; revenue is projected to come in €1.8bn ahead of the April forecast, including a €1bn overshoot in tax receipts, but spending is now forecast to be €800mn above the initial target, including over €500mn in voted expenditure, perhaps indicating that the current Health overspend will not be corrected.

Voted  current spending is projected to fall in 2015, by €1.3bn from the 2014 outturn, but again this hides a significant change in plan, as next year’s figure is almost €1bn above that envisaged last April . As a consequence the GGD  in 2015 is only €0.5bn below that projected in April, coming in at €4.7bn. This is 2.4% of forecast GDP and hence well below the 3% target, although had the initial spending plans been adhered to the deficit would be substantially  below 2%.

The figures are on an unchanged policy basis and so the Minister has significant leeway now to raise spending and give some tax relief, with the scale of any largess dependent on his final target. In addition, he may announce some ‘savings’, so increasing the scope for a potential stimulus, including lower debt interest on foot of some repayment of the IMF loan, refinanced at cheaper market rates. That might amount to say €300mn. so reducing the pre-Budget deficit further, to €4.4bn. Consequently a final target of say, , €5.4bn,, or 2.8% of GDP, would imply a spending and tax package of around €1bn, not counting any tax buoyancy on foot of the stimulus  or positive impact on GDP.

The global economic outlook looks cloudier than it did a few months ago , with the euro area particularly weak, which adds a greater degree of uncertainty than usual to any fiscal forecast. The Minister may  err on the side of caution and go for a lower forecast deficit but the difference now is that he has far more options than envisaged earlier in the year and certainly far more than in recent budgets. A deficit of 2.8% would also mean a strong primary surplus (the budget balance less interest payments).

Irish High Steet spending: some volume growth, boosted by falling prices

The volume of Irish retail sales excluding the motor trade peaked in December 2007 and fell by almost 15% over the following four years , recovering marginally in 2012 before making a double bottom early last year ( using  a 3-month average to reduce some of the volatility in the CSO data). Since then the volume of spending has picked up somewhat, rising by 5.2% from the low,  with the annual increase in August at 3.7% .Still a long way from the peak, therefore, but at least there is some signs that consumers have returned to the High Street.Total retail sales are up 6.8% in volume terms, thanks to strong car sales, and overall consumer spending has  also shown some growth, albeit at a slower pace (spending was up an annual 1.8% in the second quarter) implying that spending on services has yet to show the same forward momentum.

The upturn in  High Street sales is widespread, with most areas seeing some increase in volumes over the past year. The most pronounced is in Furniture and Lighting, up an annual 20.7% , no doubt reflecting the pick up in housing transactions and completions, followed by Electrical goods with an 11.6% gain. The volume of spending on Footwear and Clothing is also recording strong growth( 5.4%)  as is Motor Fuel (4.4%), which is not surprising given the surge in car sales this year (an increase of 24% according to the retail data). Spending on Food tends to be less volatile than most other areas and that too has seen growth, with the volume of sales up 3.2%, although spending on beverages and tobacco is down.

Spending in volume terms is  also falling in some other areas, including Pharmaceuticals and Cosmetics (-0.8%), Newspapers and Books (-1.6%) while in Bars the figure is -2.7%. It is not clear that the  latter has yet bottomed, with the volume of sales down over 37% from the peak , while the fall in the volume of Newspaper and Book sales is even starker, at over 47%, although there has been some modest growth in the past few months.

Some good news then for at least some areas of the High Street, although a closer look at the data reveals that the growth in actual spending is not as pronounced, with price falls still evident in most sectors. The price of Electrical goods is down by over 5%, for example, so reducing the increase in the value of spending to 5.8% despite a volume increase of 11.8%, with Furniture and Lighting also seeing a pronounced price fall, this time of 3.6%. A few sectors have attempted to raise prices, including Newspapers and Bars but the total  price deflator for retail sales ex autos fell by 1.7%, so reducing the rise in the value of sales to 2% despite a volume increase of 3.7%. The pace of price decline has eased a little over recent months, from -2% earlier in the year, but it is clear that although conditions for High Street businesses are indeed improving, the volume figures give a more upbeat trend than  experienced by many retailers.

 

Irish GDP surges, impressing the Government but not consumers

Ireland’s quarterly GDP figures are volatile and often surprise, with the latest no exception; the economy grew by a seasonally adjusted 1.5% in q2, following a 2.8% expansion in the first quarter, the latter revised up marginally from the initial release. That surge in Irish output left the annual growth in real GDP in q2 at an extraordinary 7.7% and means that in the absence of revisions the average growth rate for 2014 as a whole would average 5% even if GDP was to remain flat in the second half of the year. The consensus growth forecast has moved steadily higher as the year  has unfolded , from an initial 2% to around 3%, but this latest data will no doubt prompt a further substantial upgrade- the Finance Minister has already mentioned 4.5% and that requires a fall over the second half of the year. Some commentators prefer GNP as a better measure of economic activity in Ireland (it adjusts for net  external flows of profits, interest and dividends) but that tells a similar story-indeed, the annual GNP  growth rate in q2 was 9%, although base effects in the second half may mean that the annual  GNP growth rate in 2014 will also be around 5%.

The monthly external trade data had implied a strong  merchandise export performance in q2 (the Patent Cliff impact on chemicals appears to be over, at least for now) but the national accounts included  even stronger figures,  which alongside a better performance from service exports resulted in a 13% annual increase in export volume. Import growth was also very strong, at 11.8%, but such is the dominance of exports (now 117% of GDP)  that annual GDP growth would have been 4% even if the other components made no contribution.

In the event they all contributed. Investment rose by 18.5% on the year, adding 2.5 percentage points to GDP growth, following strong gains in construction output and spending on machinery and equipment. Government spending  also rose , and by a puzzling 7.9% in volume terms, which sits uneasily with the idea of spending cuts and fiscal austerity and may reflect problems with the price deflator. The third component of domestic  demand, personal consumption, also rose, but by a modest 1.8%, and even that was flattered by base effects from last year as the quarterly increase in q2  this year was just 0.3% following a meagre 0.2% rise in q1. It is clear from other data sources that Irish households are still  paying down debt at a steady clip and it is impossible to say when this deleveraging will end. Employment growth has also slowed sharply in 2014 and in the absence of a marked change in household  behaviour personal consumption growth in 2014 is likely to be nearer to 1% than the 2% many expected.

Such is the volatility  and unpredictability of exports and investment that real GDP  growth in 2014  could be over 6% or nearer 4%, but we currently expect  5%.Export prices are falling, as is the deflator of government spending, and for that reason the rise in nominal GDP this year may be less than that recorded for real GDP – we expect 4%.That would give a nominal GDP figure  in 2014 of €182bn but still substantially above the €171bn forecast in the 2014 Budget. Tax receipts are also  running well ahead of target and so we now expect the General Government deficit for the year to emerge at 3.4% of GDP compared with the 4.9% originally forecast by the Government. The implication is that a fiscal adjustment of the order of €2bn in 2015, as originally envisaged and still advocated by the Fiscal Advisory Council (although the Council’s latest paper did  not take account of the q2 GDP figures), would probably push the deficit well below 2% of GDP and therefore comfortably under  the 3% target set by the Excessive Deficit procedure. The  strength of tax receipts had moved the Government towards a much smaller adjustment in any case  but the latest GDP figures appear to have convinced them to abandon austerity and at worse go for a neutral budget, with tax cuts funded by higher taxes elsewhere, mainly the Water Charge.

Early repayment of Ireland’s IMF debt

The Irish Government is exploring he possibility of  early repayment of the monies borrowed from the IMF and below we examine the issue.

How much does Ireland owe the IMF?

Ireland  arranged to borrow €22.5bn from the IMF as part of the bailout deal agreed with the Troika, although the fund actually lends in Special Drawing Rights (SDR’s) , the IMF’s unit of account, which is constructed as a basket of four currencies (the US dollar,  euro, Yen and Sterling) with the dollar having the largest weight followed by the single currency. Ireland drew down SDR19.47bn from early 2011 through to late 2013 and the loans have maturities ranging from 4.5 years to 10 years, with an average maturity of 7.3 years. The SDR ‘s value against the euro changes daily and at the time of writing buys €1.16 so Ireland currently owes 22,6bn in euro terms, although the loan has to be repaid in SDR’s. In that sense Ireland can be said to have borrowed from the IMF in four currencies.

What is the interest rate on the loans?

Ireland has borrowed from the IMF under the Extended Fund Facility and the rate charged is floating, depending on the 3-month SDR rate ( itself a weighted basket of rates in the four constituent currencies) and a surcharge. The SDR rate is currently only 0.05% (the euro and yen rates are actually negative) so the premium is much more significant. That depends on how much one borrows relative to ones contribution to the fund , or quota, which is determined by GDP, population and other economic criteria. Ireland’s quota is SDR1.258bn and a country can borrow up to 3 times that (or SDR3.77bn in this case ) at a 1% surcharge. Anything beyond that carries a 3% surcharge , rising to 4% if the loan term extends beyond three years

So how much is Ireland paying?

If we assume the loan term will average 7.5 years Ireland would pay 1.05% per annum on the first SDR3.77bn and on the remaining SDR15.7bn 3.05% over the first three years and 4.05% on the final 4.5 years. This gives an average blended rate of 3.15%. In fact the loan  also carried a one-off 0.5% charge so averaging that out over the term  and adding it to the cost gives an annual rate of 3.21%. This is an SDR rate of course and Ireland raises taxes in euros, so the NTMA will use the swap market to convert euros in to the appropriate basket of currencies. Consequently the NTMA quotes an average euro rate for the loan based on a 7.5 year maturity swap, and that was put at just under 5% in March of this year, implying an annual interest payment in euros of over €1bn on the IMF loan. Ireland’s total interest bill on all outstanding debt  this year is just over €8bn.

How much is Ireland paying in the market?

Bond yields have collapsed across the euro zone on the expectation that short term rates will stay low for a very long time and, probably, in anticipation of bond purchases by the ECB. Irish yields have fallen precipitously too, with a government bond maturing in 10 years currently trading at 1.85%, with shorter maturities at much lower  yield levels. It would therefore appears that Ireland could borrow much more cheaply in the market than the current cost of the IMF loan  and it would make sense to borrow at a longer maturity given the low level of current yields..  The Minister for Finance has mentioned a figure of €18bn for repayment and yields would presumably rise if Ireland announced a much heavier issuance schedule  than currently planned ( only €10bn was slated for this year in total) but even at ,say 3.0% for a 20 year bond , the saving would be around €360mn a year , not counting any additional costs involved in breaking the swaps.

What’s the problem then?

There are two issues. One is that the other members of  the Troika need to sign off on early repayment, which brings in EU Governments  and in some cases parliaments. The second is the Promissory note deal, which involved the Irish government issuing  €25bn in long term bonds to the Irish Central bank . The ECB was never happy with the transaction, believing it to be ‘monetary financing’, and insisted that the Central bank sell the debt into the market over time. The schedule for the latter is light, with sales of €0.5bn a year out to 2018 before rising to €1bn a year, but Draghi now appears to be linking any ECB support for early IMF debt repayment with a more rapid sale by the Central bank.

Does the Prom deal matter that much?

The Irish Government  borrowed the €25bn from the Central Bank , which in turn borrowed from the ECB, and  the Government pays  a floating rate coupon of 6-month euribor ( currently 0.2%) plus 262 basis points on the bonds , implying an annual interest payment of €700mn. That  means a  large profit for the Central bank as its borrowing cost is now virtually zero, and most of this profit is transferred to  the exchequer. If ,say, the Central bank sold €5bn into private sector hands that circular flow of income would be broken, costing the exchequer, with interest payments now leaking out into the investors who bought the bonds from the Central bank while the latter would use the proceeds  of the sale to repay the ECB.

So the ECB’s call is key?

The ECB’s view is therefore very significant, as a much more rapid sale of bonds by the Central bank, in return for a nod on the IMF repayment,  would reduce the benefit of  the latter, by driving up Irish yields and  via a reduction in Central bank and therefore exchequer income. It is an irony though, and one that may well be pointed out by the Irish authorities, that Draghi is now  keen for the  ECB  to  eventually embark on full scale bond purchases across the euro area, which some might view as ‘monetary financing’ too, although no doubt Frankfurt will argue that the cases are different.

 

Irish household wealth is rising but debt repayment ongoing

Mario Draghi may be doing his best to encourage European consumers to borrow and spend but the evidence in Ireland still points to ongoing deleveraging, despite rising household wealth. The debt burden is now falling steadily, however, in contrast to the situation over recent years, but is still extremely high by international standards and it is anyone’s guess when the deleveraging process will come to a close.

The Irish Central bank publishes financial accounts data which tracks each sector’s assets and liabilities and the figures for the first quarter have just been released. Loans to households fell by €1.9bn in q1, bringing the total decline since the peak in mid-2008 to over €39bn. That deleveraging has dwarfed any new lending, which explains why the outstanding amount of personal credit is still falling despite a pick up in new loans. The absolute debt figure is now back to the level last seen in mid-2006.

Of more significance is the debt burden, which is generally expressed relative to disposable income. On that metric the burden peaked at 218% in late 2009 but did not fall materially for some time after that despite deleveraging because household income, the denominator, was also falling, reflecting rising unemployment, falling wages and an increase in the tax burden. Income finally stabilized  in 2012, ( although it is still volatile even on the four quarter total used by the Central Bank ) and has started to inch higher, so the debt ratio has started to fall at a steady clip, declining to 182% in the first quarter of 2014 from 185% in the previous quarter and 198% a year earlier. The household debt burden is now also back at 2006 levels, although a long way above the 133% recorded a decade ago.

Households are reducing their liabilities but their financial assets are climbing, and indeed have been rising for the past five years, largely reflecting growth in the value of assets held in pension and insurance funds. Household’s financial assets amounted to €339bn in q1, leaving net financial worth of €165bn, a record, and some €100bn above that recorded at the nadir of the financial crash.

Most Irish household wealth is in the form of housing, however, and when that is added we arrive at a  total net worth figure of €509bn. The housing component actually fell in the quarter ( national house prices declined in q1) and wealth  is still some €200bn below the peak but it has recovered by €50bn over the past year.

House prices rose again in q2 so that alongside the pick up in house building ( up an annual 37% in h1) will have boosted wealth  in recent months. The data on bank lending implies that debt repayment has remained a feature as well so the net household wealth figure will probably record a further rise in q2. Rising wealth is generally seen as positive for consumer spending but we have never seen the pace of deleveraging evident in Ireland of late (households have been net lenders rather than borrowers for over five years now) and we do not know how long that will continue to dampen personal consumption.

Ireland now has jobless growth instead of growth-less jobs

The relationship between Ireland’s reported GDP and employment has been a puzzle of late. Output in the economy barely grew last year yet employment soared and this year has seen GDP growth pick up but employment effectively stagnate; growth-less jobs has given way to jobless growth. The unemployment rate is still falling, it has to be said, but the explanation for that is more to do with a decline in the labour force rather than any strength in labour demand. Average pay is also declining and so the picture painted by the recent labour market data is certainly at odds with the recovery narrative currently holding sway.

The main source of information on Irish employment is the Quarterly National Household Survey (QNHS), which means that sampling errors are always present. That aside, the data shows that employment bottomed in the third quarter of 2012, having fallen by a seasonally adjusted 327k (or 15%) and  then rose sharply in 2013, with the annual increase in the final quarter at 61k or over 3%. Not all industries participated and agriculture saw by far the biggest increase in employment, but on the face of it the pace of job creation was extraordinary, and one usually associated with a booming economy. Yet the recorded GDP data, which measures the output of the economy, initially showed a fall in 2013, and although subsequent revisions have been positive, the latest vintage still has real GDP growth last year of only 0.2%.Nonethelss the strength of job creation precipitated a substantial fall in the unemployment rate, to 12.2% at end 2013 from 14.2% a year earlier, despite a rise in the participation rate. The implied tightening of the labour market was not evident in terms of pay, however, as average weekly earnings fell by 0.7% last year.

The data revisions to the national accounts had left exports stronger than previously thought and a positive contribution from external trade was the main driver of the 2.7% rise in Irish GDP reported for the first quarter this year, offsetting another fall in domestic demand. The data left the annual growth rate in q1 at 4.1% and, as we expected, has prompted a substantial upward revision to the consensus growth projection for 2014 as a whole, with many private sector forecasts now  well over 3%. Many analysts are also anticipating a pick up in personal consumption, in part predicated on a strong employment figure, but the latest QNHS data, for q2, is very disappointing in terms of job creation; employment rose by 4.3k on a seasonally adjusted basis in the quarter bringing the increase in employment in the first half of the year to just 5.5k. Coverage of the figures tended to emphasise  the annual increase in employment of 37k but  the quarterly flow implies that  the annual rise will slow sharply by the end of the year .

The unemployment rate fell further in the quarter, to an average 11.5%, despite the weak employment figures, reflecting a fall in the labour force and a decline in the participation rate. The decline in the latter was particularly acute for those  over 16 and under 24, with more staying on at school or entering third-level. Emigration is a factor too, although the net figure fell  to 21k in  the year to April 2014, with an increased inflow of  61k partially offsetting a reduced outflow of 82k.

The surprisingly weak employment figures should also be set against the data on average earnings, showing an annual fall of 1.1% in the second quarter, which again would not indicate a tightening labour market overall, although some industries did see strong annual pay growth including construction (6%), the hospitality sector (5.3%) and manufacturing (4.2%). Some have pointed to the strength of income tax receipts as being inconsistent with the pay and jobs data, which is worth noting, although it should be remembered that the 2014 Budget did include measures to boost income tax by over €200mn as well as strong carryover effects from 2013.

As is often the case with Irish data we are left with a confusing picture- is the economy growing very strongly, as indicated by the GDP figures, or is it much weaker  as implied by the employment figures?. The latter does seem to suggest that domestic demand, and particularly the domestic service economy, where most jobs are located, remains in the doldrums. This does not preclude 3.5% GDP growth but it does mean that growth will again be driven by the multinantional export sector, which is not labour intensive.

 

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.