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.