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.



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.

Irish Consumer Spending continues to Disappoint

According to the CSO’s first estimate, the Irish economy, as measured by real GDP, contracted by 0.3% in 2013. This was well below the consensus , which envisaged modest growth, largely reflecting an unexpected plunge in activity in the final quarter, which left real GDP in q4 0.7% below the figure a year earlier. This in turn now makes it less likely that average growth in 2014 will be above 2% as the current consensus expects.

Much has been made of the impact from the Patent Cliff on Irish merchandise exports and hence GDP ( the corollary, a fall in multinational profits, helped to boost GNP, the income of Irish residents, by 3.4%) but a key concern for the Government must be the continued weakness of consumer spending. Personal consumption in volume terms fell by 1.1% last year against a Department of Finance expectation of -0.2%. Moreover, consumption fell in the final quarter and the annual change in q4 was also -1.1% which makes the Department’s forecast of 1.8% average growth in consumption this year look a little optimistic.

A number of indicators would point to stronger consumption than has emerged. Consumer confidence, for example, has risen sharply and is currently back at levels last seen in early 2007. Employment is also rising strongly, by  2.4% on average last year, which offset a 0.7% decline in average wage earnings implying a net increase in total wage income. The retail sales data has also been positive, with a volume  rise of 0.7% in 2013 or 0.8% if one excludes cars.

The value of retail sales fell last year, however, implying that retailers have to cut prices to boost sales, and spending by tourists is excluded from the personal consumption figure as it is meant to capture expenditure by Irish residents. In addition spending on services accounts for over half of personal consumption and that remains weak. One factor may relate to the nature of the employment gains, with some half due to a growth in self employment, and there is no guarantee that the self employed will make money. Indeed, income tax receipts are flat on the year, and weak self employed earnings may be responsible, at least in part. The CSO also believes that the disposable income of Irish households fell over the first nine months of last year (that measure includes transfers and other sources of income alongside wages and adjusts for taxes on income). Households are also continuing with the deleveraging trend evident since 2008, with the repayment of another €5bn  of  debt in the first three quarters of 2013 bringing the total over the five years to €35bn. We do not have figures for recent months but net lending by banks and outstanding credit card debt is still falling, with  a decline of €416bn in net mortgage lending in January the highest monthly fall on record.

The trend in employment. if maintained, does provide the main argument supporting the expected pick up in consumer spending and buoyant car sales have given retail sales a strong start to the year but the trend in wages and deleveraging may also continue as drags on spending and hence GDP, with household’s attitude to debt a particular area of uncertainty.