Irish net debt ratio projected at 28% of GDP in 2025 Budget

The Irish 2025 Budget was delivered against an unusual fiscal backdrop. Unlike virtually all its euro peers the Government is running a fiscal surplus and the debt ratio is low and falling, helping to make Irish 10yr bond yields the third lowest in the Euro Area.The economy is also around full employment, prompting some concerns that an expansionary budget would be inflationary, although the current inflation rate is only 0.2%, the lowest in the EA. In addition, as a result of the recent ECJ ruling on the Apple tax case, €14.1bn is to be transferred from an escrow account to the Irish Exchequer, €8bn this year and the balance in 2025.

A feature of the Irish budgetary process is the publication of a White Paper a few days head of the Minister’s presentation, setting out pre-Budget estimates of the Exchequer position at end-2024 and a forecast for 2025. The former showed tax receipts some €13bn ahead of the original Budget 2024 projection, largely due to the €8bn from Apple and another large overshoot (€5bn ) from current Corporation tax receipts. Government current voted spending is also expected to come in some €3bn ahead of that projected, but still leaving a very large current budget surplus of €30.8bn in the White Paper, partially offset by a capital deficit of €17.5bn( which included a €4bn transfer to the Future Ireland Fund) and therefore an overall Exchequer surplus of €13.3bn.

The Government decided to spend over €2bn of this in 2024 in the form of a ‘cost of living package’, comprising a raft of social welfare supports. Consequently the Budget package on the day amounted to €10.3bn instead of the €8.3bn figure announced a few months ago.

For 2025 that package included €1.6bn in income tax and USC reductions, which generally went beyond indexing credits and bands and will reduce tax paid by 2.2% for a single worker on average earnings. Underlying tax revenue is forecast to rise by just 3% in 2025 (and fall marginally in total given the Apple tax impact)but the forecast current budget surplus is still large, at €28.6bn. The capital deficit is projected at €20.7bn (including €6bn as announced in transfers to the Future Ireland Fund and the Infrastructure fund), so leaving an Exchequer surplus of €7.9bn. The General Government balance is forecast at €9.7bn or 1.7% of GDP, down from €23.7bn (4.5% of GDP) in 2024.

The Government’s choice of how to allocate the Apple funds was interesting, in that it chose not to transfer all or part to the two Future Funds,which have restrictions on use in terms of timing, and instead plans next year to announce additional spending on various capital projects , including Water, Electricity and Transport. As a consequence the NTMA which had already overfunded this year, will have much larger cash balances and so will not need to fund to the same extent as previously thought in 2025. Ireland’s gross debt falls only modestly therefore this year, from €221bn to €217bn (41.4% of GDP) but net debt falls sharply to €166bn (32% of GDP). Next year the gross debt ratio is projected at 38% of GDP and the net figure at 28%.

Finally, the macro forecasts underlying the Budget arithmetic paint a benign picture, with the economy projected to remain around full employment against a backdrop of sub-2% inflation and real wage growth around 2.5%.

Irish GDP contracts in second quarter despite booming service exports

The Irish GDP data often surprises but the second quarter figure was unusual even by recent standards. The flash estimate,. produced in July, had projected a 1.2% quarterly rise but the national accounts revealed a 1% contraction in GDP. Yet this occurred despite a 12% quarterly increase in exports, which would normally translate into very strong GDP growth but in this case was offset by a collapse in capital formation . This component fell by 65%, driven by a massive decline in multinational investment in intangibles, largely R&D.

Spending on intangibles is notoriously volatile and may or may not rebound in the second half of the year but of more significance is the recovery in Irish exports and specifically the surge evident in service exports. These now significantly exceed merchandise exports ( €125bn versus €79bn in q2 alone) , driven by extraordinary growth in computer services (including software), which amounted to €66bn in the quarter, with annual growth of 27%. Ireland is Europe’s own silicon valley.

Construction spending fell in the quarter but another surprising feature is the limited growth seen in consumer spending, which did rise by 1.0% in the quarter but that followed zero growth in q1, leaving the annual increase at just 1.3%. Despite this and a rise in Government spending, modified domestic demand also fell in the quarter, by 0.5%, due to a contraction in adjusted capital formation.

Irish GDP ended last year down by an annual 9.1% so achieving a positive average growth figure for 2024 was a tall order, although possible given a very strong rebound in exports. That has indeed taken place (exports in q2 were up an annual 18%) but the Intangibles figure has been a big negative, with the result that GDP in q2 was still 4% down on the same period last year, following -4.7% in q1. The consensus did expect a modest positive growth figure for 2024 and this is less likely now in the absence of a huge rebound in capital formation. Modified domestic demand is also expected to increase this year and that looks on track, albeit with modest growth, with the annual rise in q2 slowing to 1.5% from 2.2% in the first quarter.

One final, again unusual, feature in the release was the Balance of Payments figure. This receives little attention now given Ireland’s euro membership but the current account surplus in Q2 alone was €35bn , equivalent to 28% of GDP.

ECB rate policy unfathomable

The market is giving a high probability to another ECB Deposit rate cut at its next meeting (12th September) , perhaps influenced by the previously announced decision to reduce the refinancing rate at that point, because there is nothing in the Central Bank’s decisions or messaging to support that view or indeed that rates will be a lot lower by this time next year.

The ECB staff forecasts project inflation oscillating around the current 2.5% over the remainder of this year before falling slowly to 2% by the final quarter of next year and then marginally below target in 2026. Given the presumed lags in monetary policy that might argue for easier policy now but given the large forecasts errors in 2021 and 2022 the Governing Council seems to have lost faith in any model based forward projections. The forecast decline in inflation is also not based on any economic weakness (growth picks up and unemployment actually falls ) but driven by a combination of higher productivity growth and a marked deceleration in wage inflation ; compensation per employee falls from 4.8% this year to 3.5% next and then 3.2%.

In the absence of any faith in forward projections the ECB states that ‘the Governing Council will continue to follow a data-dependent and meeting-by-meeting approach’ and will not pre-commit to a particular rate path. Yet a host of Council members clearly signalled well ahead of the June meeting that a rate cut was very likely , duly delivered, but inflation had surprised to the upside,wage inflation had re-accelerated in the first quarter and the Staff raised their inflation forecast, albeit modestly.The published account of that meeting revealed, not surprisingly, that some members were uneasy about what appeared to be a decision at variance with the data-dependent mantra.

Perhaps as a consequence, post meeting rhetoric from Council members generally pushed back on the idea that the Bank had embarked on an easing cycle, and today’s July policy meeting reinforced the data dependent message. However, the announcement also explicitly referred to ‘elevated’ service inflation, which has moved back above 4%, and ‘high’ domestic price pressure.

So if the inflation rate over the next few months does pan out as the ECB expects (i.e stay around 2.5%) why would they cut rates?. One argument is that the ECB itself believes that monetary policy is restrictive, with an emphasis on ‘real’ rates, which have risen given the steep fall in actual inflation. So a Deposit rate of 3.75% translates into a real rate of 1.75% if inflation does fall to target. This approach also utilises the idea of a ‘neutral’ real rate, at which policy is consistent with sustainable real GDP growth and target inflation, but that rate is not observable and estimates of where it might be vary, although most argue it is perhaps around 1% or even lower, consistent therefore with a Deposit rate of 3% or below.

That theoretical approach sits uneasily with ‘data dependence’ however, and as long as the latter remains the mantra any rate decision would appear to be dependent on the latest inflation reading, or at least the service component,although the current inflation figure is backward looking, making a nonsense of the idea that monetary policy be set to influence activity and prices 18 months or so in the future.

Why have higher rates not had a bigger impact on the Irish housing market?

The latest release of the CSO’s residential price index, for April, shows a further acceleration in annual house price inflation, to 7.9%. The index has risen by 144% from its 2013 low and is also 9.5% above the previous cycle high in 2007. The latest release is also notable in that Dublin prices (+8.3%) are now rising at a faster clip than in the rest of the country (+7.5%)for the first time in seven years.

It is the case that house prices did fall in real terms in 2023 (i.e CPI inflation outstripped the rise in residential prices) but that followed a strong real rise in 2022 and real prices are now rising again, although there isn’t much evidence supporting the view that households see things in ‘real’ terms anyway. This has also played out against a backdrop of monetary tightening, which saw ECB policy rates rise by 450 basis points, albeit from historically low and negative levels.The tightening cycle was also unusually rapid , starting in July 2022 and ending 14 months later, so the impact on the Irish housing market has been limited, at least to date, and the ECB has now begun an easing cycle, following a quarter point rate cut in early June.

One factor at work has been the limited pass through from ECB rates to mortgage rates; the average new loan for house purchase in April was 4.24%, or 1.61% higher than in July 2022, the onset of the tightening cycle.This in turn reflects a combination of massive excess savings held by Irish households and the competition landscape in the banking sector. The three remaining domestic banks had seen a slippage in mortgage market share to non-bank lenders in the period of very low market rates and so sought to regain share as market rates rose by using the cushion afforded by the scale of excess deposits largely held in current accounts; in April households deposits in the Irish headquartered banks amounted to €154bn and total deposits in the banks exceeded their loan books by €75bn. In that environment the banks had little incentive to raise deposit rates and used that cheaper source of funding to regain market share from non-banks, who of course were dependent on market rates. In effect then savers subsidised borrowers and bank shareholders gained also via a significant rise in bank net interest margins and hence higher equity valuations.

Affordability did deteriorate as a result of higher mortgage rates but not to a degree that materially impacted demand for mortgages. The average FTB loan in 2023 was €285k , up from €269k the previous year, paying an average rate of 3.9% against 2.6%, but the income of the average buyer also rose , from €85k to €88k. The average term on these loans was unchanged at 29 years, meaning a monthly payment of of €1370 in 2023 against €1100 a year earlier, or 18.7% of income against 15.5% in 2022.

The number of new mortgage loans for house purchase did fall modestly in 2023, by 2% to 36k, but FTB loans rose marginally in volume terms to 25.6k. Net mortgage lending had fallen in 2022 but , surprisingly, picked up sharply through 2023 and in April this year recorded annual growth of 1.6%, with a mini lending boom evident in consumer credit, which is rising by 8.8%, in marked contrast to the picture in most other euro states.

Another factor impacting house prices was the rather odd decision by the Central Bank, in terms of timing, to effectively loosen monetary policy at the same time the ECB was tightening. This was via a change to the mortgage controls,originally introduced in 2015, with the LTI limit on FTB loans raised in 2023 from 3.5 to 4.0. The impact of that decision is clear from the data on lending, showing that 40% of FTB loans in 2023 were above an LTI of 3.5, against 13% in 2022. Government policy also plays a role here, geared as it is to supporting FTB demand via a large tax subsidy (buyers can reclaim up to €30k in income tax for a deposit) and it is notable that the average LTV for FTB loans in 2023 was virtually unchanged at 80.3%.

Most analysts had expected housing supply to fall last year but in the event completions rose to 32.6k, the highest since 2008, but this is still lagging population growth, so the housing stock per head is still falling. In our housing model the supply effect is anyway dwarfed by the impact of rising household incomes, the main driver of demand, in turn largely fuelled by changes in employment and wages, both of which have risen strongly; household disposable income rose by 10% last year on the latest CSO data, following a 7% increase in 2022. This remains the key fundamental driver of the market , rather than supply or interest rates. Employment growth is slowing,in part a reflection of the limited supply of labour, and that may dampen house price inflation to some extent, regardless of any interest rate boost . Finally, expectations can play a significant role especially in the short term, be it on interest rates or the perceived impact of government policies but are difficult to capture effectively in any model, although over time the demand fundamentals tend to reassert themselves as key.

Surge in Software exports brings five quarter fall in GDP to an end

The Irish economy grew by 0.9% in the first quarter of the year according to the CSO’s initial estimate , which followed five consecutive quarterly contractions. That decline reflected large falls in multinational manufactured exports and the recovery was also sparked by the multinational sector, albeit from service exports and such was the scale of the increase that it now looks more likely that the annual GDP figure for 2024 may show modest growth , having looked more like zero or even a further contraction such was the scale of the negative carryover from last year.

Exports in total grew by a 7.3% in volume terms in the quarter, driven by an 11% rise in services which dwarfed a 2% increase in goods. This still left the latter 17% down on the previous year, and although merchandise exports made in Ireland (dominated by organic chemicals and Pharma) were €2bn higher than a year earlier, goods processed abroad are still falling, down €14bn on the year. Service exports, in contrast, rose by an annual €20bn, to €103bn in the quarter, including an €11bn rise in computer services, largely software, and a €5bn rise in business services. It may well be that the AI impact on the sales of the likes of Meta, Google and Microsoft could have a more significant and persistent impact on Irish exports into the future.

Household disposable income in Ireland grew by an annual 10% in q1, supported by further employment growth, but the savings ratio is rising again (up to 14.7% in q1) and so consumer spending growth has been modest, at 0.6% in real terms in q1 following no growth in the previous quarter and is only 1.7% higher than a year ago. Construction spending fell sharply in the quarter, dampened by weaker housebuilding and a sharper decline in non-residential construction. Spending by Irish firms on machinery and equipment did rebound , however, so modified capital formation grew by 7% and as a result modified domestic demand also rose, by 1.4%. Overall capital formation fell though, , by a huge 40%, reflecting big declines in multinational spending on machinery and equipment and intangible assets, which also impacted imports, which fell by 6%.

As noted, the economy entered the year with a huge negative carryover effect from 2023 (GDP in q4 was down 8.7%) and the growth rebound in q1 this year still left the annual change at -6.5%. However the first quarter export performance does make it more likely that annual GDP in 2024 may well be modestly positive, at around 1.5%. The quarterly profile also means that 2024 could end the year with a strong annual carryover into 2025.

Irish Central Bank losses

One of the legacy issues stemming from the ECB’s QE operations is that national central banks across the euro area are reporting annual losses in their 2023 accounts, and flagging further losses to come. The Dutch central bank figure of €3.5bn was dwarfed by the Bundesbank’s €21.6bn , which wiped out its reserves. Against that backdrop the recently reported Irish central bank’s loss of €132m appears a very good result, although there are a number of factors at work which imply that the 2024 figure will be much higher.

In the ten years to 2023 the Central bank was recording large profits and transferring substantial sums to the Irish Exchequer , exceeding €2bn per annum on occasion, with a total of over €15bn.This in part reflected the negative interest rate the CB was paying on deposits from the Irish commercial banks but a key factor was the interest and capital gains on the €25bn Floating Rate Notes (FRN) issued by the Irish Government the CB had acquired as a result of its liquidity support for Anglo Irish Bank.The maturities varied , with an average interest rate of 6-month Euribor plus 2.63%, so the value of the notes soared in a period of very low and then negative rates.The CB sold the notes back to the NTMA over time, recording large capital gains, and that was also the case in 2023, with a gain of €1bn.

So absent that realised gain the loss would have been over €1.3bn, and as the notes have now all been sold that source of profit is no longer available, putting more emphasis on the CB’s net interest income. As a consequence of QE and the PEPP the CB held €60bn of securities for monetary purchases , receiving €379m in interest in 2023, implying an average coupon of only 0.63%. These asset purchase were funded by the CB creating deposits for the banks selling the bonds and the Deposit Facility Rate has of course climbed as a result of ECB monetary tightening, from -0.5% in mid 2022 to the current 4.0%. In 2023 the CB paid €2.8bn to Irish banks on these deposits, so giving a net interest loss of €2.4bn as a legacy effect of QE.

The deposit facility is likely to fall in 2024, so reducing the deposit interest paid, while the bonds held will gradually decline as they are no longer replaced as they mature. The CB also has other sources of income to offset its €300m in operating costs, including interest on positive Target balances at the the ECB (as a result of monetary inflows into Ireland) which are remunerated at the refinancing rate , which is currently 4.5%. The total interest earned last year was €3.4bn, but again this is likely to fall as the ECB moves to monetary easing.

The net loss of €132m loss last year was met by drawing down from the €3bn in provisions set aside for that purpose and as noted absent the gain from the FRN the loss would have been well over €1bn. Consequently the next few years may well see much higher headline losses, although the CB cannot go bankrupt as it has large reserves and can also print money. It does mean though that it may be some time before transfers to the Exchequer resume.

Full employment and spending pressures impact medium term fiscal outlook

The Irish Government has just published its annual Stability Programme update(SPU), as mandated by the EU, setting out fiscal projections out to 2027, although this will be the last update in this form as revised fiscal rules will require the publication of a five-year fiscal Structural Plan (more on that below)

For context, Ireland has been running very large current Budget surpluses , supported by substantial inflows in Corporation tax. In 2023 , for example, current revenue amounted to €90bn, against current spending of €73bn and if both are assumed to rise at broadly the same pace the absolute surplus grows over time , and was projected to exceed €24bn in 2026 . Of course the Government has used this excess revenue to fund capital spending, but this still left the Exchequer as planning to run overall cash surpluses into the future, raising the question of whether it would be better for Ireland to run down debt at a rapid clip or to use the surpluses to fund future spending.

The Government chose the latter option and set up two funds; the Future Ireland Fund(FIF) will be managed as an investment fund out to 2035, receiving an Exchequer transfer of 0.8% of GDP each year in order to help cope with fiscal pressures arising from an ageing population, while the Infrastructure , Climate and Nature Fund (ICNF)will be a shorter term counter cyclical vehicle for infrastructure spending out to 2030, receiving €2bn annually from current receipts. This still leaves the Exchequer running projected surpluses, and hence nominal debt falling,and the State running much larger General Government surpluses as these transfers are included in the latter, along with surpluses in the Social Insurance Fund.

What has changed in the SPU? .For the 2024 outlook very little, which is surprising as forecast GDP growth this year has been revised down and tax receipts to date are running behind profile. However, the Department of Finance expects this to largely correct, so tax receipts are projected to emerge only modestly behind target, with higher voted current spending offset by reduced spending elsewhere, including lower than forecast EU contributions and a lower contribution to the FIF (because GDP fell last year). The net result is that the projected Exchequer surplus is now seen some €0.7bn higher at €2.5bn, with the General Budget Surplus marginally higher at €8.6bn.

A comfortable fiscal position therefore is expected ahead of the 2025 Budget and the General Election but in contrast there are significant changes to the outlook further out. The economy is deemed to be at fill employment and so employment growth and therefore GDP growth is constrained by labour supply, although net migration is assumed to rise by 35,000 a year. Inflation has also been revised down so GDP in 2026 is now forecast at €600bn or €50bn below the previous projection. As a result tax receipts at that point are lower than was envisaged but the big change is on the spending side, with gross voted current spending in 2026 €5bn higher than forecast last October.’Core expenditure’ is still projected to rise by 5% per annum , albeit against a higher 2023 base , but the contingency reserve has been rolled on to these years, including ‘ Covid-related spending primarily in Health, costs relating to accommodating and supporting beneficiaries of temporary protection from Ukraine and expenditure related to EU funds’.

The upshot is that the Exchequer is now forecast to be running a deficit in 2026 and 2o27 , some €3bn in total, and the General Budget Surplus (which is nstill assumed to include the transfers to the two funds) is smaller , at €8.7bn instead of €14.6bn. The Exchequer deficit therefore means Ireland will actually be borrowing, albeit small sums, at least in part to fund the FIF and ICNF. Nominal debt will therefore rise modestly but given the low interest rate on the debt and GDP growth the debt ratio continues to fall, to 36.7% of GDP by 2026,although the October forecast was 33%.

As noted above this will also be the final SPU. The EU’s latest revisions to its fiscal rules put greater emphasis on each State setting out a five-year plan including spending commitments consistent with a falling debt ratio. Ireland’s debt ratio is already well below the 60% reference value set out in the Growth and Stability pact but will still be required to publish a five-year strategy, set to commence in the Autumn.

Dublin leading acceleration in house price inflation

Residential property prices in Ireland have picked up markedly over the past few months, supported by rising real incomes (given the fall in CPI inflation) and the expectation that ECB rates will fall this year, with the June policy meeting likely to see the first cut . More mortgage borrowers are certainly of that view, with 26% opting for floating rates in January, a significant change from the 5% or so seen over recent years.

The CSO’s house price index for January confirmed the more buoyant trend, with residential price inflation nationally accelerating to 5.4% from 4.1% in December. The national index has been supported by price gains excluding Dublin but that appears to be changing; Dublin prices were weak in 2023 and last summer were down an annual 1.8% but have picked up strongly of late, rising by 3.5% in the three months to January. Houses in Dublin City have seen the strongest recovery, up by 3.9% in three months, taking the annual increase to the past year to 6.2% from 2.8% in December. In county Dublin the annual change also accelerated strongly to 4.6% from 2.5%. The annual change in Dublin is flattered by base effects (as prices fell in January last year) and this is likely to remain a feature up to mid-year, with even modest monthly gains leading to a 9-10% annual figure.

That base effect will be less of a feature in the rest of the country, albeit still present, and prices have also picked up on a monthly basis, by 2.7% in the past three months. That has boosted annual price inflation excluding the capital to 6.2% from 5.3%. Annual property price inflation is strongest in the Mid-West (Clare, Tipp and Limerick) at 9.5%, followed by 9.3% in the Midlands ( Laois, Offaly, Longford and Westmeath)

Irish Tracker holders to get unexpected bonus from ECB

Tracker rates in Ireland became the norm in the early noughties,linked to the ECB’s refinancing rate (refi rate) with a spread, which averaged around 1.1% . Consequently the ECB’s current refi rate of 4.5% translates to a Tracker rate of 5.6%, although for years borrowers paid only 1.1% given the refi rate was at or near zero from 2014 to July 2022.

The refi rate is the rate banks pay to borrow from the ECB and used to be the main instrument used by the Bank to control short term interest rates in the euro area. However, that changed when the ECB started to flood the market with excess liquidity in an attempt to get inflation back up to the 2% target and so the Deposit Facility rate (the rate the ECB pays banks for deposits) became the effective operational rate . The spread between the refi and deposit rate has varied over time but since 2019 has been set at 50bp, with the current deposit rate at 4%.

That is set to change from mid-September according to an announcement setting out the ECB’s proposed new framework for guiding euro rates .The issue arises because excess liquidity is falling and the ECB is looking ahead and to the kind of operational framework they will adopt when liquidity is tighter. They have decided that the Deposit rate will still be the key driver of rates but as liquidity ebbs money market rates may well start to rise above that floor.Banks will be able to borrow all they need at the refi rate, so that will put a ceiling on rates but the spread between the two will fall to 15bp from the current 50bp in order to maintain a tighter corridor.So even if the deposit rate in September was still 4% the refi rate falls to 4.15% and Tracker rates decline by 35bp. Of course the market is actually priced for cuts to the Deposit rate by then, to say 3.5%, which if it materialises would mean tracker rates will fall by 85bp to 4.75%. The market is currently priced for a cycle low in the deposit rate of 2.25%, which implies a Tracker rate of 3.5%..

Irish economy contracts by 3.2% in 2023.

The Irish economy, as measured by real GDP, contracted for four consecutive quarters last year, with the annual figure falling by 3.2% . Nominal GDP also declined, to €505bn from €506bn in 2022. The pace of decline accelerated through the second half of the year and real GDP fell by 3.4% in the final quarter, substantially worse than the initial -0.7% flash estimate. That left the annual change in the final quarter at -8.7%, which gives a very weak carry over into 2024, and the economy may well struggle to record positive growth even with a recovery in external trade.

Exports have been the engine of Irish growth for a long time now but 2023 saw a sharp reversal of the seemingly inexorable rise, with a 4.8% fall in volume terms following double digit annual gains over the previous four years. Service exports held up well, rising by over 8%, but there was an extraordinary collapse on the merchandise side, by €45bn or 13%. Goods shipped from Ireland fell by €10bn, reflecting weaker Pharma and organic chemicals, but goods outsourced to production abroad, largely in China, fell by €34bn, probably down to a specific phone manufacturer.Exports in total ended the year down 9.5% so a strong recovery would be required to give positive export growth for 2024.

Imports had also weakened through the year but rebounded sharply in q4 on the back of a surge in service imports related to intellectual property. That resulted in a modestly positive import growth for the year as a whole. The IP service import is also captured and offset by Intangibles in capital formation (therefore largely GDP neutral), so that component also rose modestly in 2023, despite a 1% fall in building and construction.

Consumer spending rose by over 10% last year, but prices increased by 7% so spending in real terms grew by 3.1%, with a notable switch by consumers to cars and services amid soft retail sales. Despite this growth, modified domestic demand rose by only 0.5%, dampened by the fall in construction and a decline in investment in machinery and equipment.

These GDP figures and indeed the modified domestic demand outturn sit uneasily with other data such as tax receipts and employment growth (up by 90,000 last year or 3.4%) and in this case GNP might be a better reflection of underlying economic activity: that adjusts GDP for profit and interest flows, and the net outflow was lower last year so GNP actually rose strongly, by 4.4%.