ECB’s negative rates trap

June this year will mark the fifth anniversary of the ECB’s decision to cut its Deposit rate into negative territory, with three subsequent moves  taking it to the curent -0.4%. That, alongside excess liquidity of some €1,800bn, means that it is the deposit rate and not the  zero refinancing rate which drives short term money market rates, and these have also been negative for years now.

Three other European Central Banks have negative policy rates -Denmark, Sweden and Switzerland- as well as the Bank of Japan , while both the Federal Reserve and the Bank of England chose to cut rates to very low but nonetheless  positive levels.

In theory, low interest rates are expected to boost economic activity and inflation by encouraging households to borrow and spend instead of saving, and to boost  capital investment by the business sector. Low rates relative to other economies may also lead to a currency depreciation, which , again in theory, is thought to boost exports and hence economic growth. Negative rates are therefore  merely an extension of lower rates, it is argued. Such  rates in the EA have certainly helped to lower the cost of funds for the banking sector, as often pointed out by the ECB, but one would have to conclude that the net effect has been disappointing; monetary growth has been limp, the growth in bank lending to the private sector has been modest ( annual growth slowed to 3% in January)  and core inflation has remained stubbornly anchored around 1%.

It is also apparent that negative rates have had negative consequences. It has been evident for some time from the ECB’s Bank Lending surveys that most banks report pressure on net  interest margins, given that rates payable by borrowers have fallen, as has the yield on bonds held by banks (many of which are also negative), but that zero is the effective lower bound for rates payable to retail depositors. Higher loan volumes might offer an offset but, as noted, credit growth across the zone has been tepid and very weak in some countries (Irish mortgage growth only turned positive in 2018 ). The knock-on effect is that European banks are generally trading well below book value , in contrast to their US peers, which may not be a concern to many but is of  concern to the ECB as it fears the consequences for future credit growth.

Negative rates are also a crisis measure, by definition,  and that signal is probably encouraging households to save more rather than less, despite or even because of the meagre returns, Similarly, it is the prospect of return rather than the cost of borrowing which drives business investment, so negative rates may well dampen the former because the of the message on the economic outlook they send.

When will rates turn positive? Last year the ECB grew increasingly confident that underlying inflation in the EA was picking up, helped by stronger wage growth, and  duly signalled that the first upward move in rates would occur from around September 2019. That forward guidance remains in place but the market is now only fully priced for a 10bp  increase in the Deposit rate in the summer of 2020, given  the recent weak data and the lack of any upward move in core inflation. The rhetoric from the ECB’s Governing Council has now changed and it would not be a surprise if the forward guidance was tweaked at the upcoming  policy meeting.

Market expectations change, of course, moving with the flow of data, but for the moment 3-month rates are not expected to turn positive  until the summer of 2021. The ECB may therefore be stuck in a rate trap, in that rates will only turn positive in response to a material pick up in core inflation, but that outcome is rendered less likely by negative rates.

Has Irish Unemployment hit its cycle low?

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

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

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

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

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

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

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

Ireland now a nation of savers, not borrowers

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

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

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

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

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

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

Marked slowdown in growth of average new mortgage in 2018.

New mortgage lending in 2018 emerged in line with our expectations,continuing to grow but at a slower pace than the previous year, reflecting the impact of tighter Central Bank controls and the absence of adequate housing supply. The fourth quarter figures also confirm that the average mortgage is still rising but at a much slower pace, consistent with an easing in house price inflation.

FTB lending in the first half of the year was  growing at a pace well ahead of the Central Bank’s limits , implying a need for mortgage providers to curb lending growth in order to end the year in compliance with the controls. There was certainly  a notable weakening in mortgage approvals over the summer months, with annual declines, before a modest pick up again in the final quarter. Actual drawdowns in q4. at 9,600, were  much stronger relative to approvals than earlier in the year, so by acting  on approvals banks had  now secured some headroom to meet the Central Banks annual lending limits.

The stronger final quarter brought total drawdowns for house purchase for the full year to 32,123, and 9.2% ahead of the 2017 figure. This represented a notable slowdown in lending growth as the latter had risen by over 18%. In value terms, new lending for house purchase rose to €7.3bn last year, a 13.5% increase  on 2017, but again this represents a pronounced deceleration in the pace of growth. from 29%. What is most striking in the data is the trend in the average new mortgage for house purchase, which averaged €226,000 for the year, a rise of just 4%, with the final quarter showing an annual increase of only 1%. This is consistent with slowing house price inflation and also indicates that affordability is becoming a bigger issue.

Another notable trend in the BPFI figures is the strength of re-mortgaging, which rose from €700m in 2017 to €1.2bn in 2018, with top -up mortgages at €221m. Indeed, lending for house purchase last year fell to 80% of total mortgage lending, from over 90% pre the Central Bank controls. Total mortgage lending in 2018 was therefore €8.7bn (i.e. house purchase plus re-mortgaging and top ups) as against €7.3bn in 2017 and a cycle low of under €2.5bn in 2011.

For 2019 , the outlook is likely to be strongly influenced by the shape of Brexit that emerges  as expectations play a strong role in both mortgage demand and housing supply,  so the market would be badly affected by an outcome which results in a UK recession, with significantly negative implications for Ireland. Absent that, transactions, which probably grew by less than 5% last year ( the CSO data is only available till November) will likely pick up, given stronger house completions, so boosting the volume of new loans, but against that weaker house price inflation will dampen the size of the average  new mortgage and hence the growth in the value of lending.We will produce a more detailed forecast in the next few weeks.

ECB rates lower for longer , Redux

Last June the ECB had grown more confident that the ongoing economic upturn would eventually result in inflation rising to nearer their target and at that month’s press conference announced that net asset purchases would ease and eventually cease at the end of the year. The Governing Council also made a significant change to its forward guidance on interest rates, which were now expected to remain at existing levels until ‘through the summer of 2019’, so replacing the previous ‘extended period’ with a more specific date for the first upward move.

At the time headline inflation had risen to 1.9%, with the ex-food and energy measure at 1.3%. Euro area growth was  expected to moderate only marginally, to 1.9% in 2019,  so the idea that the monetary policy stance was likely to change seemed plausible, and the markets duly priced in a 10bp increase in the deposit rate  for around September 2019.

Events did not materialise as the ECB expected, however. Growth in the EA slowed to 0.2% in the third quarter, with Germany and Italy both experiencing contractions, and the high frequency data implies that the fourth quarter figure could be weaker still. Consequently, the annual growth rate in q4 may well slow to 1.1% and initial indications from the January PMIs imply an annual figure of well below 1% in the first quarter, which makes the Bank’s 1.7% average growth forecast for 2019 look very optimistic. Inflation, too, has disappointed the ECB, with the ex food and energy rate seemingly anchored at 1.1%, with a core figure of 1%.

Some observers, including many on the Governing Council, had expected the slowdown that emerged in the second half of 2018 to be short-lived, particularly as the US economy is still growing strongly, albeit at a less dynamic pace than earlier in the past year. It now appears that others on the Council have become more concerned that the slowdown could be more protracted, and at the latest  ECB press conference the risks to the outlook were now deemed to be on the downside. Indeed, Draghi actually used the term ‘recession’, albeit giving it a low probability.

The ECB prefers to announce policy changes against the backdrop of a fresh set of forecasts, and so it chose to leave its current forward guidance on rates unchanged. That ‘summer of 2019’ guide now looks redundant, however, at least as far as the market is concerned, with the first rate rise now pushed out to around June 2020.  Longer term rates have also fallen, with 10-year Bund yields back below 0.2%, while  the cost to a commercial bank with a good  credit rating of borrowing three year money is -7 basis points. The euro has also faltered , and is trading back below 87 pence sterling. In fact Draghi acknowedged the divergence and implied that the Bank might well have to change its guidance at the March meeting, when of course it will have an updated set of staff forecasts.

There is still an enormous amount of excess liquidity in the euro system (around €1,800bn) but there is also some speculation that the ECB may announce a further TLTRO, which  was introduced in 2016 and is currently providing over €700bn in long term funding to euro banks at negative or zero rates, with a high uptake from  Italian and Spanish banks. For a number of reasons a substantial repayment may take place in June, prompting talk of an additional tranche to maintain high liquidity levels.

The economic outlook can change, of course, and a combination of a managed Brexit alongside an easing of trade tensions could spark an upturn in activity, hence prompting a change in rate expectations. The ECB also seem more concerned than in the past about the impact of negative rates on bank margins, another argument for moving rates up. Against that, the data flow remains relentlessly negative and there must be a risk that the ECB may have to change stance again, and adopt  additional measures to support activity. A generalised slowdown or recession would also probably prompt a big EU rethink on the fiscal side as monetary policy has taken most if not all of the strain in recent years.

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

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

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

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

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

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

The Next US Recession

Over the summer months the current US economic expansion became the second longest on record, and if growth continues into next July will exceed the  last decade long upturn, which ended in 2001. Longevity, per se, does not mean a US downturn is inevitable any time soon but it is a curious fact that every decade over the past 150 years has seen a recession, be it mild as in 1990/91 ( lasting 8 months) or severe (18 months from 2007/09).

Recessions can have different catalyts, although it  often after the event that the process becomes clear.  In the past oil  price shocks have often precipitated a decline in US GDP but output  across the developed world is now less oil intensive than in the past. Moreover, the US is now the world’s largest oil producer and many expect it to become a net oil exporter over the coming years, so high oil prices may now be  neutral or even positive rather than negative for the economy.

Financial crises can also have serious effects on the real economy, as evidenced a decade ago, although the true extent of   any excess leverage and associated imbalances may not be fully understood ahead of the downturn. One concern currently flagged in the US is the relatively low yield on higher risk corporate bonds and the growth of ‘covenant-lite’ loans, with borrowers accessing credit  with fewer restrictions on collateral and payment terms.

Monetary policy mistakes are also often cited as causing recessions. The impact of interest rate changes on the economy is notoriously ‘long’ and varied’, making errors more likely, with central banks seeking to tighten sufficiently to keep inflation around target but ending up overdoing it , causing real activity to slow or even contract.

The Fed is currently immersed in a tightening cycle of course, and has raised rates eight times over the past three years. This cycle is unusual in many respects, however, in that the target rate is now a quarter point range rather than a stated figure. The starting point for rates was also very low (0%-0.25%) so that we are still at low rate levels three years on, both in nominal terms ( 2.0%-2.25%) and in real terms (around zero). In addition, the Fed is reducing its balance sheet by allowing some of the bonds it purchased under QE to roll off without reinvesting the proceeds, a policy dubbed ‘Quantitative Tightening‘. No one knows how this will pan out as it has never been undertaken before.

What is known is that the shape of the yield curve does have some predictive power in term of recessions, in that inversion ( longer dated yields fall below shorted yields) has pre-dated downturns in the past, although the time-lags have varied . For that reason the flattening of the 2’s-10’s yield spread in the US has caused much comment, particularly as it is currently in to 12bp. Indeed, the curve is actually inverted in the 3yr-5yr segment. The  3month-10yr spread has also narrowed appreciably, to 50bp, and the New York Fed uses that to model the probability of a recession, which has risen to 20%.

 

The market is  still expecting the Fed to raise rates further and another quarter point increase is given a high  probability at the FOMC meeting this month, taking it to 2.25%-2.5%, but beyond that rate expectations have changed; the futures market  for December 2019 is trading at 2.67% , implying one further rate increase next year, against an expectation of around 3% just one month ago, So the market is currently priced for a rate cycle that ends in 2019 and at a level very far removed from that indicated in the  September FOMC’ ‘dot plot’, which envisaged  rates at 3.0%-3.25% in a year’s time and a peak of 3.25%-3.5% in 2020.

So the big fall in longer dated yields ( the 10 yr has declined from 3.25% to 2.92%) can in  part be attributed to that change in rate expectations, in turn supported by a series of  weaker than expected readings in core inflation. Expectations can change, of course, and an upside surprise in wage growth would prompt a sharp reaction, with yields heading higher again. By the same token,  if the the recent upturn in weekly jobless claims was followed by a weak employment number longer term yields would no doubt fall further, as the Fed’s tightening intent is strongly predicated on  the view  that the labour market will strengthen further, taking the unemploymenr rate down to 3.5% next year.

The external environment for the US has also become cloudier, with weaker activity in China and a marked slowdown evident in the Euro Area. That said, America is essentially a closed economy so any pronounced deceleration in the pace of economic activity will likely be domestic in origin, be it from investment or consumer spending. Slower growth is generally expected next year but nothing more serious, although forecasters have a notoriously bad record at predicting recessions. The stock market is better, albeit erring on the opposite side, predicting some that never materialise.

 

New Mortgage lending continues to slow amid fall in approvals

Irish household incomes are rising strongly, driven by robust employment growth, and that would normally support the demand for mortgages, particularly against a backdrop of rising property values and low interest rates . Indeed,Irish financial institutions have seen new mortgage lending rise year on year since 2013, albeit at an erratic pace,  reaching €7.3bn in 2017 from under €2.5bn four years earlier. The number of new mortgages drawn down  annually for house purchase rose from 13,000 to over 29,000 over that period.The strength of new lending also began to offset mortgage redemptions a year ago  and the annual change in net mortgage lending  has picked up since, to 1% in September.

The market has had to adapt to  constraints on new  mortgage lending, introduced by the Central Bank in 2015, including a number of changes to the controls, most notably from the beginning of  this year, with FTB lending  allowed in excess of the 3.5 LTI limit reduced to 20% from the 25% observed in 2017. The constraint applies to lending over the calendar year  as opposed to approvals,  and the latter may not translate into actual drawdowns for a number of reasons. Banks have therefore become much more cautious on approvals, paricularly to FTB’s,   and approvals  to that segment  have been falling on an annual basis since March, declining by an annual 3.3% in the three months to September.

In fact approvals to all borrowers for house purchase  is also down relative to last year, at  9,741 in q3 against 9,876 in the same quarter of 2017. The relationship between approvals and  drawdowns can vary a lot from quarter to quarter and actual lending for house purchase in q3 was stronger than the approvals trend implied, albeit still confirming  a slowdown in the pace of  new lending.

Over 8,700 loans for house purchase were drawn down in the third quarter, 8% up on the previous year but compared with annual growth of 9.4% in the first six months, itself about half the pace seen in 2017. The value of lending for house purchase  is also slowing, emerging at €2bn in q3, up an annual 11% against 16.5% growth in H1. The implication is that the average new mortgage is also increasing, as one would expect given rising house prices, but again there is a noteworthy change; the average  mortgage for house purchase in the third quarter was €228,000, just 3% up on the previous year.

Central Bank research indicated that mortgage controls would dampen mortgage lending and house building  while also impacting  house prices and that certainly seems to be playing out, although the possible effect on prices is being offset to some degree by the scale of non-mortgage buying, which still appears to be running at about 50% of transactions. One other striking feature of the mortgage market is the strength of re-mortgaging, such that lending for house purchase has fallen to 80% of total mortgage lending, from 94% three year ago.

Finally, we have trimmed our estimates for new mortgage lending for 2018 as a whole, with €8.2bn now envisaged, including  €6.8bn for house purchase. The number of loans for the latter is projected to be just over 30,000 from 29,400 last year.

ECB rate rise next year not a done deal

In June, the ECB announced it was likely to end its net asset purchase  programme in December and that it expected to keep interest rates at their present level ‘at least through the summer of 2019‘ , albeit with a caveat relating to inflation developments remaining in line with the Banks expectation of a steady convergence to target. Some confusion ensued as to when the summer actually ends but the ECB has since indicated it is happy enough with market expectations of a rate rise at the September or October meetings next year.

Any change is more likely to initially  involve the  ECB’s Deposit rate rather than the Refinancing rate, and the latter is more significant for existing Irish mortgage holders as Tracker rates account for over 40% of the stock of mortgage loans.However,  it would then  only be a short period of time before a rise in the refinancing rate occurred if the ECB was  set to embark on monetary tightening.

Why has the Governing Council decided to signal a probable rate rise? In part because the EA economy performed strongly in the latter part of 2017 and although growth moderated in the first half of this year, to 0.4% per quarter, that is still above what the Bank considers to be potential, which has resulted in further falls in the unemployment rate. The ECB is also more confident that wages are finally responding to the tighter labour market, and as a result expects underlying inflation to pick up steadily , with the ex food and energy measure forecast to average 1.8% in 2020 from 1.1% this year. As such , the Council is more confident of a ‘sustained convergence’ in headline inflation to target.

In fact headline inflation has been above target for the past four months, oscillating between 2% and 2.1%, boosted by higher energy prices. Yet that is also squeezing household incomes ( wage growth was 1.9% in q2) and core inflation ( which excludes food , energy, alcohol and tobacco ) has remained stubbornly at 1.1% or below in recent months, slipping back to 0.9% in September.

The  economic outlook also looks less robust than it did. The ECB maintains that the risks to EA growth are balanced but at their September meeting  it was noted that a case could be made that the risks had tilted to the downside. Since then , the global outlook certainly seems to have deteriorated amid a backdrop of falling equity markets, rising trade tensions, weaker growth in China, a rising dollar, Brexit uncertainties and  Italy’s apparent willingness to breach euro fiscal rules.

Indeed, some of the hard data in the EA has been noticeably weaker over the summer months and the PMIs have also softened, with the latest reading for the EA as a whole dropping to a 2-year low of 52.7 in October, That is consistent with GDP growth of only 0.2% a quarter and it will be interesting to see whether the ECB reiterates its balanced risk view at the upcoming meeting.

It may be that the current weakness in sentiment and activity proves temporary but what may also concern the ECB is that more forward looking indicators also signal weakness ahead. The major European equity indices are all heavily in the red year to date while monetary indicators are not reassuring; M3  growth has slowed to 3.5% while the growth rate of lending to the private sector has remained becalmed at 3.4% in recent months, with mortgage lending slowing a little to 3.2%.

It is unlikely that the ECB will do a volte- face on its forward guidance at this juncture but the risks to their view on inflation have risen and it is not a done deal that rates will rise in 2019.

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

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

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

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

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

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