Irish real GDP now 50% above pre-crash peak

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

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

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

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

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

Irish Q3 GDP: Volatility again to the Fore

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

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

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

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

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

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

 

 

 

Irish growth surge begs questions about upcoming Budget

The Irish economy is now growing at a very rapid pace, both in real and nominal terms, and much faster than envisaged by consensus forecasts or by the Irish Government when framing the 2015  or indeed  the 2016 Budget.  Real GDP grew by 1.9% in the second quarter,  leaving the annual increase at 6.7%, while  first quarter growth was revised up to 2.1% and the annual change to 7.2%. That means that  growth averaged 7.0% over the first half of 2015  so forecasts for the year as a whole are likely to move up to at least  6% or higher. Moreover, nominal GDP is soaring, rising by an average  12.5% in the first half of the year, and GDP for 2015 may exceed €210bn,  implying a General Government debt ratio below 100%, from 107.6% last year.

The initial recovery in the Irish economy was driven by exports but of late domestic demand, which is more labour intensive, has moved to the fore. The external trade data  is still extremely strong,  albeit affected by recent Balance of Payments  (BoP) changes, and while exports  still greatly exceed imports in absolute terms,  import growth is now outpacing, so reducing or even eliminating the positive  contribution of trade to GDP. In q2 imports rose by 6.3%  so  exactly offsetting the impact of  a  5.4% increase in exports. Looking at the annual change in q2, export growth of 13.6% was dwarfed by a 16.9% rise in imports, resulting in a  negative (-0.4%) contribution to GDP.

Domestic demand was generally expected to pick up in 2015 but  the data has also  surprised, with the second quarter seeing a 4.8% rise, leaving the annual increase at an extraordinary 10.1%. Investment spending was the main driver, rising by over 19% in the quarter and by 34% over the year. Construction output is growing but the main factor was a surge in spending on machinery and equipment, although this is very volatile, particularly given the influence of aircraft orders. One puzzling feature in terms of the other components of demand is the performance of consumer spending, which has also picked up but at a slower pace than indicated by retail sales; consumption rose by just 0.4% in q2  and the annual increase slowed to 2.8% from 3.7% in q1.

Commentary on the national accounts often includes caveats about the GDP numbers, with some preferring GNP , the income of Irish residents, as a better measure. Yet growth is also extremely strong using that metric, averaging 6.7% over the first half of the year, although multinational profit outflows did pick up in q2 and the differential between the two measures may widen over the rest of the year.

Irish GDP is now  5.7 % above the previous peak but the unexpected strength of activity in 2015 raises a number of policy issues. On the face of it the economy is growing at a rapid clip and  employment is rising strongly , which would not signal the need for a further boost  to demand from fiscal policy in 2016, particularly as monetary policy is extraordinarily easy and the exchange rate has depreciated. The Government has already received advice from a variety of quarters urging little or no stimulus and the GDP  figures might serve to reinforce such views. Against that, CPI inflation is around zero, wages are only beginning to rise, credit is still contracting and Ireland ran a BoP surplus of  €4.3bn over the first half of the year, a picture hardly consistent with an overheating economy.

There is also an election due within six months, of course, but times have changed in that the Government is now constrained by EU fiscal rules, including one which limits the growth in real exchequer spending to the growth in potential GDP. The latter figure  is determined by the European Commission (EC), using a 10-year average ( including estimates of the current year and forecasts four year ahead) and as it currently stands it means virtually  zero growth in real spending in the 2016 Budget. This  real limit is translated into a cash figure by using the EC’s forecast for price rises across the economy ( the GDP deflator) which is currently  1.6%,  giving a permitted  expenditure figure of €1.3bn to allocate between spending increases and tax cuts.

Yet the GDP deflator is currently rising at an annual 5.2%, so the 1.6%  forecast for 2016 looks too low. Moreover, the potential growth rate  forecast also looks less credible, given the 2015 data. For example, Ireland’s potential growth rate for the year  was put at 2.8% , which implies that the economy may currently be operating 3-4% above capacity, given that the EC assumed  the economy was around full employment in 2014, which  is not consistent with the  observed wage and price behaviour.

There is now little more than a month to the 2016 Budget, so interesting times ahead, although whatever transpires, a buoyant economy can no longer translate into the tax and spending package we might have seen in the past.

 

 

The Euro, Capital Flows and Speculative Trades

Quantitative Easing is generally seen as being negative for the currency in question, and the evidence would seem to support this, albeit not in all situations (sterling, for example). The ECB certainly believes that to be the case, the rationale being that lower bond yields in the EA will prompt investors to seek higher returns abroad, so resulting in portfolio outflows and hence selling of the single currency. The euro has certainly depreciated, both in broad trade weighted terms and against the other majors, and in May was 9.5% below its trade weighted value a year earlier, incorporating a 19% fall against the US dollar and a 12% decline against sterling.

Yet we also know that short-term currency moves can be strongly influenced by speculative positioning, with traders shorting a currency in the belief that QE should  be negative for its FX value, which then sets up something of a self-fulfilling prophecy for a time , as any initial weakness then prompts further selling given that momentum trading appears to be the predominant style at the moment. Data in the Commitment of Traders weekly report from the CFTC ( incorporating  FX futures ) provides a useful guide to speculative  positioning, and from that it is clear that the market started to build a very large short position in the euro/dollar last autumn and one which increased further  following the QE announcement in January.  The position peaked at a  record high in late March, at the equivalent of €28bn, and has unwound sharply since  to currently stand at €11bn, the lowest in almost a year. So the  initial fall in the euro and recent recovery would seem to owe something at least to speculative trades.  It is also worth noting that the unwind of the euro shorts coincided with a strong increase in short yen positions and a fall  in the yen against the US dollar.

What about more fundamental drivers of the euro, as captured in the Balance of Payments? The first point to note is that the EA runs a current account surplus, largely reflecting a positive merchandise trade balance, and one which is growing; the surplus rose to €212bn in 2014 and amounted to €245bn in the twelve months to April 2015, the latest data available. That surplus would therefore generally put upward pressure on the currency unless offset by capital outflows, which brings us back to the ECB’s hope that QE will stimulate such flows.

There has certainly been a significant change in terms of net  portfolio flows. with a net outflow of €160bn in the twelve months to April 2015, against a net inflow of €50bn in the year to April 2014. Moreover, outflows do indeed tend to be in terms of bond purchase, with  EA buying of foreign debt instruments  amounting to €119bn in the first four months of this year alone, which alongside some modest selling of other assets resulted in a rise in total portfolio outflows of €109bn.  Yet QE has also been associated with a significant rally in European stock markets, and  the same period has seen portfolio inflows of €76bn,  including €96bn in equities. So since the announcement of QE the outflow from debt investors has been offset to a fair degree by the inflow from equity investors albeit still leaving a net  portfolio outflow of  €33bn in the four months to end-April.

Direct investment flows also matter, however,  and here again the first four months of 2015 have seen strong inflows, amounting to €86bn, offsetting outflows of  €35bn to give a net inflow figure of  €51bn.  So net capital flows in total (portfolio plus direct) are small  to date  this year and actually a net positive (€19n) which added to a cumulative current account surplus of €69bn implies a inflow of €88bn. The errors and omissions on the BOP data can be very large and there are other financial flows associated with the banking sector but on the basis of the available figures  it is difficult to build a case that QE has led to the flows anticipated by the ECB or on a scale which might have led to a significant euro weakness. It is early days yet, of course, and higher US rates later in the year may trigger greater bond outflows, or indeed an outcome from the Greece negotiations which is seen as negative for the single currency.

 

 

Irish Domestic Demand rises in 2014 after 6-year decline

The Irish economy grew by 4.8% in real terms in 2014 according to preliminary data from the CSO, which was marginally below the consensus estimate, albeit slightly better than anticipated by the  Government. Nominal GDP expanded by 6.2% , taking it to €185.4bn, again slightly above the official estimate, which reduces the previously published debt  ratio for 2014  by around 1 percentage point , while not affecting the deficit ratio.

The Irish economy bottomed as far back as the final quarter of 2009 but  domestic demand has remained weak and in that context perhaps the most significant aspect of the 2014 data was the first rise in domestic spending in seven years; final domestic demand ( the sum of personal consumption, government consumption and investment expenditure) rose by a very healthy 2.9%. Government spending was flat ( the puzzling rise evident earlier in the year was revised away) and investment grew strongly, by over 11%, in part due to further growth in building and construction. Personal consumption also rose,  but by a modest 1.1%, which was  well below most forecasts  made last year. It is  certainly the case that the national accounts estimate is low relative to the recent trend in retail sales but in general it would seem that deleveraging has proven a very significant drag on household spending, partially offsetting  the positive effects of rising employment and falling prices. The net effect is that consumer spending now accounts for 45.6% of Irish real GDP, the lowest share in a decade. That said , consumption did rise strongly in the final quarter of 2014 , and with wages now picking up,  2015 may see household spending gain some momentum.

Net exports continued to provide the main impetus to Irish GDP last year, although the growth of external trade was massively stronger than anyone has initially anticipated, partly due to a rebound in chemical exports  and partly to methodological changes to the Balance of Payments (BOP) ; the volume of exports rose by 12.6% with imports up by 13.2% (the former have a much higher weight in GDP so net exports still made a positive contribution). As a result  Ireland’s current account surplus on the BOP rose to a record €11.5bn or 6.2% of GDP. The implication is that Ireland is now generating substantial excess savings, with the private sector surplus more than offsetting the public sector deficit, which of course it needs to do in order to repay external debt.

On a quarterly basis the national accounts  revealed a pronounced slowdown through the year, with GDP expanding by a seasonally adjusted 3.5% in the first half ( revised down from an initial 3.9%) and by just 0.6% in the second, with the final quarter recording a very modest 0.2%. Domestic demand  slowed in H2 , despite a 1.3% increase in consumer spending in the final quarter, and imports outpaced exports, although again the new BOP format had an impact, boosting merchandise exports but also increasing service imports. The respective growth rates of the two  have been spectacular as a result; the latter ended the year with annual growth of 22%, and the former at 27%.

Eternal trade has therefore ended the year at much higher levels that anyone initially envisaged  and adds a further degree of uncertainty to  GDP forecasts for 2015, particularly as the monthly merchandise trade data now gives little clue to the total external trade position. That aside, the headline outturn is unlikely to prompt any major revisions to the existing consensus ( around 3.8%) and the main positive is that domestic demand is growing again, with some signs that consumer spending is finally  beginning to pick up.