Double digit growth again for Ireland in 2022, 5% next year

Following the release of National Accounts for Q3 Ireland looks on course to record double digit real growth for 2022 as a whole: the annual average year to date is 11.7% and we now expect a figure of 12.4% for the full year.Moreover, thanks to higher inflation nominal GDP is likely to rise by 17% to over €500bn, from €175bn a decade ago.

Real GDP grew by 2.3% in the third quarter, following modest upward revisions to growth in the first half of the year, now put at 2.2% in q2 and 7% in the first quarter. Exports again performed strongly,. increasing by 4.8%, although this was dwarfed by a 27% surge in imports., albeit largely due to a massive increase in service imports, in turn captured by capital investment in intangible assets by the multinational sector. As such this is broadly neutral for GDP (the investment boost offset by higher imports) but is extremely volatile, not only quarterly but also in the annual data.

Capital formation actually fell in the quarter when adjusted for this multinational effect, declining by 4.6%; construction spending fell marginally but there was a 7.2% fall in investment in machinery and equipment. This was the main factor behind a 1.1% contraction in modified final domestic demand, with personal consumption barely rising (0.3%) and government consumption recorded a modest 0.3% fall.

In fact personal consumption looks to have held up well through the year , despite the hit to real incomes caused by much higher CPI inflation , largely due to robust growth in nominal disposable income, which may average over 7% in 2022, boosted by strong employment growth. We expect 6% consumption growth in 2022 and the savings ratio , although moderating, is higher (over 19% average ytd) than most expected as a result of the income growth.

We have revised up our capital formation estimate for the year as a result of the q3 outcome and now expect a rise of 23%, with a 9% increase in construction spending and a 28% rise in machinery , equipment and intangibles. The latter is also reflected in an upward revision to our import estimate, but exports too are stronger than we initially envisaged, and we now forecast a 14% increase in that component. Consequently the external sector is again the main driver of Irish GDP growth , with that export performance offset to some degree by higher multinational profits outflows, so reducing GNP growth to a forecast 8%. Modified final domestic demand is estimated to rise by 6.5%, with the recent slowdown offset by a strong carryover impact earlier in the year.

GDP growth is much stronger than earlier consensus estimates and Ireland’s fiscal position is also much more robust than initially envisaged by the Government; the 2022 Budget projected a €7.7bn Exchequer deficit , predicated on 2.6% growth in tax receipts, but by end-November the Exchequer had recorded a €14bn surplus, with receipts up 25%, with all the major tax headings well ahead of expectations. In response, the Government has put €2bn into the Reserve Fund, so reducing the surplus to €12bn. Corporation tax was expected to fall but is over 50% up on the previous year, maintaining a pattern of underestimation evident for the past decade. Ireland’s debt to GDP ratio will probably end the year below 45% and 10-yr bond yields have been trading around 45bp over Germany and as such below France and Belgium.

Inflation in Ireland may have peaked at 9.2% on the CPI measure in October, with falling fuel prices the main disinflationary factor, although the average for the year is likely to be around 8%. We expect a steady decline through 2023 with the average next year at 4.6%. This will again dampen real income growth , particularly as employment and labour force growth is slowing given the scarcity of labour, which has pushed the unemployment rate below 4.5%. We expect very modest employment growth next year and a modest rise in the unemployment rate to over 5%, and as a result project only 2% growth in real consumer spending for 2023.

House completions may surprise to the upside this year (we expect 29,000) but look on course to decline in 2023 given some of the forward indicators and we also expect total construction spending to fall by 8%, contributing to an overall 4.5% fall in capital formation, although the intangibles component can always spring a surprise. Consequently we expect modified final domestic demand to grow only marginally, by o.5%. GDP growth as a whole will again be largely determined by the export performance, which in truth seems impervious to global demand ; the annual change in exports is still strongly in double digit territory so even even with little growth through the year the average export figure for 2023 is still likely to be 8%. That assumption helps deliver GDP growth of 5%, with GNP increasing by 4%.

Housing Market Update

Following the release of recent data on housing supply, mortgage lending and residential prices we have updated our models and forecasts for the Irish housing market, including projections for 2023, summarised on the website.

We are revising up our estimate of house completions this year, and now expect a figure around 29,000, which if broadly right will be the strongest supply figure since 2008. Annual completions have been in a 20,ooo-21,000 range for the past three years and as such well below the 33,000 figure deemed by the Government to represent annual demand. Completions this year have picked up and the 7,500 figure for q3 brought the four-quarter total to just shy of 28,000, prompting our upward revision. Some analysts had reduced their completions forecasts earlier in the year, in response to the surge in housing construction costs, but that is more likely to impact supply next year.

We have also revised up our estimate for new mortgage lending. For house purchase we expect 36,500 new loans, 6% above the 2021 figure,and again another 14-year high. The double-digit rise in house prices is reflected in much higher average mortgages, and we expect that figure to be around €279,000, up from €250,000 in 2021. The resulting total figure for house purchase is €10.2bn against €8.6bn last year. Total new lending has been boosted by very strong growth in switching, which amounted to a third of mortgage loans in the third quarter. This has no effect on net lending, nor on the housing market , but is substantial now, and we expect total lending this year to rise by €4bn, to €14.3bn.

House prices are still rising but at a slower monthly pace than last year, so the annual inflation rate in residential prices is slowing, to 12.1% on the latest CSO figure (for August) from a high of 15.0% in February. We expect this trend to continue, with a December forecast of 8.0%. This would give an average figure for the year of 12.5% which is in line with our model forecast- falling real incomes act to dampen prices but offset by strong price momentum, low interest rates and the lagged impact of weak supply,as the growth in the housing stock has not kept pace with the growth in population.

The interest rate impact this year has been surprising, in that the average new mortgage rate has actually fallen since the turn of the year, despite the significant rise in market rates, which has led to significant increases elsewhere; the average new rate in the EA in September was 2.40%, 111bp higher in the year, against 2.58% in Ireland, which is 11bp lower.Consequently, although affordability has deteriorated in response to the rise in the average new mortgage it is still below the long run average on our affordability model.

Expectations play an important part in short term house price movements, albeit hard to adequately capture in modelling, and there is a risk that prices weaken more than we expect if potential buyers decide to postpone purchases given uncertainty about the outlook for inflation, employment and interest rates. On the latter we expect new mortgage rates to start to climb soon and so affordability deteriorates in 2023, to above the long run average. However, inflation is expected to slow and absent a big employment shock real household incomes will be broadly unchanged after a fall this year. On the supply side the recent commencement data points to a weaker supply total next year, and we expect completions of 25,000. This is supportive of prices but we still expect a further slowdown, with a 2% annual end-year rise expected in 2023 .New purchase mortgage lending will also slow, to €9.5bn, with the total figure ( i.e. including switching) marginally higher than 2022, at €14.5bn.

Irish mortgage rates and ECB rates

The ECB began to raise its main lending rates in July , followed by another round of increases in September with a further set expected at the October 27th meeting.The impact on Irish mortgage borrowers has not been as straight forward as many anticipated ; existing borrowers with Tracker rates have seen a significant rise but the average new mortgage rate has actually fallen this year, reflecting both specific Irish liquidity issues and an unusual set of factors affecting the pass through of ECB rates to the Euro money market as a whole.

Half of the outstanding mortgage loans of Irish banks are at a fixed rate so those borrowers will be unaffected by money market changes, at least in the short term. In terms of variable rates 60% of those borrowers (and so 30% of all borrowers) are on Tracker rates, directly linked to the ECB refinancing rate, with an average spread of 1.05%. The refinancing rate was cut to zero in 2016 , meaning that those on Tracker rates have paid extraordinarily low borrowing costs for over six years, but that has changed; the refinancing rate has risen to 1.25% and will probably hit 2% by month end, so pushing the average Tracker rate to 3.05%.

Higher ECB rates have also pushed up rates on new mortgage loans across the zone, with the average in August rising to 2.21% from 1.29% at end-2021. Irish rates actually fell over the same period, to 2.64% from 2.69%, and are now below that of Germany, illustrating that local conditions can play a significant role.

There are two specific Irish factors at work. One is the scale of excess deposits in the banking system here, reflecting a longer term upward move in the household savings ratio, the impact of the various Lockdowns on spending and the low rate of house building, with a concomitant impact on mortgage lending, the main driver of Irish bank assets. In August, Irish household deposits amounted to €147bn (from €109bn three years earlier) while in Irish headquartered banks deposits exceeded loans by €83bn (which is probably the main reason the Central Bank has eased the controls on mortgage lending)

The average interest rate on most of these deposits is virtually zero (0.02%) so domestic banks here have a significant funding advantage over the main non-bank mortgage lenders. The latter have made significant inroads in the market of late (accounting for 13% of all new mortgage lending in 2021) but are more dependent on market rates , so offering Irish banks the opportunity to regain some market share.

Ultimately higher market rates will have an impact of course but the pass through from ECB rates to money market rates is not 100%. A huge factor is the amount of excess liquidity in the euro system, which currently stands at €4,500bn, in turn reflecting the impact of ECB long term loans to EA banks (TLTRO III) and QE .Short term money market rates would therefore be determined by the ECB’s deposit facility rate, which in theory should set a floor for rates, but that is not happening; both the overnight rate (0.658%) and the one week rate (0.67%) are well below the the 0.75% deposit rate.

How to reduce that excess liquidity? For the moment the ECB is reinvesting all its maturing bond holdings under QE and so could start to reduce the amount it reinvests , as per the US Fed. Yet that might clash with their desire to prevent any further widening of the spread in long term borrowing costs between Germany and Italy or Greece. The TLTRO has a three year maturity and can be repaid earlier by banks but that too has thrown up problems for the ECB, as the terms are such that banks are unlikely to do that; the average rate paid by banks for the loans will be substantially below the rate they can earn by simply depositing the money back at the ECB (Irish banks drew down €21bn, which has been a significant boost to their profits, with French and German banks the main beneficiaries).

Modifications to the TLTRO are widely expected at the upcoming meeting, but retrospectively changing the terms of a three year loan would not be a good look for the ECB. Changing the rate charged on excess reserves may also be on the table.

The pass through from ECB rates to the market may not be 100% but its still pretty high, so further monetary tightening from Frankfurt will have an impact on retail rates. Market expectations as to the peak in rates this cycle are volatile, shifting in response to the latest inflation release (still surprising to the upside) and indicators on the real economy(pointing to a probable recession) . Longer term fixed mortgage rates will be influenced by the 5-year swap rate in the market, and although that has fallen back to 3% from 3.25% earlier this month it was below 1.5% in August. Shorter term,one-month rates are priced to rise to 3% next year. Remember that reflects expectations about the ECB deposit rate and implies a refinancing rate of 3.5% and therefore a Tracker rate of 4.55%. These market expectations may not be fulfilled of course but we probably need some short term downside surprise in the inflation figures to placate ECB hawks and not just weak economic data.

Irish Housing Market Update

House prices in the US, the Euro Area(EA) and the UK have seen strong and persistent growth in recent years, driven by similar factors- low supply relative to past experience, very low interest rates by historical standards and significant monetary and fiscal stimuli in response to the Pandemic. Monetary policy has now changed and signs of a slowdown in the housing cycle have appeared although as yet this has precipitated a softening in price momentum rather than any significant price falls.

The latest Irish residential price index illustrates the point; prices rose by 2.3% nationally in the three months to June, but at a slower pace than seen in the same period a year earlier so the annual change in prices slowed, albeit not dramatically, to 14.1% from 15.0% in March.In Dublin price inflation slowed to 11.7% from 12.5%, while the figure excluding the capital was 16% from 17.1%.

June also saw the index climb back up to the previous cycle peak recorded in April 2007, although house prices are now 2.4% above the previous high after reaching that level in March, while apartment prices are still 14% below their 2007 peak. Prices remain supported by limited supply and a big fall in the real interest rate (nominal mortgage rates on new loans have not risen year to date while the CPI has spiked) although real incomes are falling and hence acting as a negative for house prices. Prices did rise strongly in the latter half of 2021 and that base effect alongside slower monthly increases for the rest of this year may result in and end-year house price appreciation figure of around 8%.

On supply , annual completions have been around 21,000 over the past three years and the 2022 total may well pick up to around 26,000 given that the figure for the first half of the year was over 13,000, although some analysts have paired back their initial forecasts in response to the surge in construction costs. This may dampen housebuilding in the coming year rather than impact supply already under construction however.

Transactions have also picked up this year which is consistent with an increase in completions, amounting to 32,615 in the first six months of the year, against 31,405 in the same period of 2021. For the full year we expect 72,000 from 68,000 last year and 67,000 in 2019.

The number of new mortgages relative to market transactions has risen in recent years to 59% from a low of 50% in 2015 and looks on course for a similar share this year. New lending for house purchase rose to €4.4bn in the first half of 2022, from €3.5bn in the same period last year, reflecting a strong rise (10%) in the average new mortgage, to €267,000 , and a similar percentage increase in the number of new loans for house purchase, taking that total to over 16,000. For the full year we expect the latter to rise to 34,000 with a value of €9.9bn. The headline new mortgage lending figures include tops ups and switching, and the latter has risen sharply over the past few years and we expect a figure of €2.5bn in that category this year, up from €1.6bn in 2021. Overall mortgage lending is forecast at €12.6bn from €10.5bn in 2021.

As noted above new Irish mortgage rates in June were unchanged from the end-2021 figure, at 2.68%, in contrast to experience elsewhere in the EA, where rates rose fro 1.31% to 1.94%. This reflects the high level of deposits relative to loans in Ireland, allowing the main lenders to absorb the rise seen in longer term market rates. That is unlikely to continue particularly as July saw the first of what is likely to be a series of ECB rate increases. The share of fixed rates in new lending has been well over 80% in recent years and so the share of variable rates in terms of outstanding loans has now fallen below 50% so lessening the impact of ECB actions.

Finally, rents are also rising very strongly, with the CPI in July recording a 12.9% annual increase in rents actually paid by tenants. In our view employment is the key driver for rents, alongside the housing stock, and the former will probably rise by over 100,000 this year or 5%. The housing stock per head is still falling, exacerbated by a dwindling supply of properties for rent, so it is not surprising to see double digit rental increases. Employment growth may slow somewhat in 2023 as workers are scarce and on that basis we may see some easing in rent inflation, back to single digits, but absent an employment shock rents are unlikely to slow appreciably.

ECB rate rise will hurt but not as much as in the past

The first ECB rate rise in over a decade was universally expected later this year and it is now likely to be announced on the 21st July. The most recent data has led to the capitulation of the more dovish Council members, with its combination of record low euro area unemployment, another fresh high in the headline inflation rate , at 7.5%, and a big jump in the core rate, to 3.5%.

The market has been pricing in higher rates for some time although expectations are volatile and at the time of writing longer term rates have fallen from the recent highs, albeit with 1-month euribor still priced at 1.25% by end 2023, or over 1.75% above the current level. For this year, three quarter point increases are fully priced in, taking rates well into positive territory by Christmas.

Higher money market rates will eventually feed through into retail rates but the impact on Irish households may well be less painful than in the past. First, rates are much lower than at the beginning of previous tightening cycles – the average rate on outstanding mortgages is currently 2.45%, including a variable rate average of 2.16%. Second, household debt here has been falling for 14 years and is now down to 98% of household disposable income, against well over 200% at the peak of the Tiger era. Third, in the aggregate households now have far more cash and deposits than debt, with the gap widening to €54bn in the final quarter of 2021.

A fourth factor relates to the mortgage market itself which in the past was largely based on variable (floating) rate debt, meaning a relatively quick pass-through from wholesale rates to most borrowers. In recent years that has changed as around 85% of new loans are fixed, with the majority over three years. Over time, the proportion of outstanding mortgages on variable rates has fallen and is now down to 50%, against over 90% when the ECB last raised rates in 2011.

Irish fixed rates are generally on a shorter term than the EA norm and so over the next few years many will have to revert to a new fixed rate or to a variable and both are likely to be higher, although given the hit to real incomes from inflation (now 7%) a few years respite will be welcome.

Although an ECB rate increase looks inevitable now, the impact on Ireland, at least initially, will also depend on which rates the ECB choose to adjust. Short- term money market rates are currently tied closely to the ECB deposit rate, at -0.5%, and that will move up in order to push up market rates. The refinancing rate is zero and the spread between the two rates has varied historically, from 0.25% to as wide as 1%, so it is not a given that the refinancing rate will also move up in July, although on balance that appears most likely.

When the refinancing rate moves may be open to debate but not the impact here as 30% of outstanding mortgages are on Tracker rates i.e. at a fixed spread over the refinancing rate. That percentage has been falling steadily as mortgages mature (it was still as high as 50% in 2015) and the average rate has been extraordinarily low for some time (1.05%) but if the refinancing rate does rise by 0.75% by year-end that will increase Tracker rates by the same amount.

One final point . Two major mortgage lenders are leaving the market which all things equal will reduce competition for loans, although a number of new niche lenders appear to be picking up market share in terms of new lending. How mortgages are funded is key though, and the remaining banks have a huge pool of excess deposits, paying zero or even negative rates , to call upon, against other lenders who are solely reliant on market rates .Ultimately higher market rates will be passed through but the timing may vary depending on that funding mix; new Irish mortgage rates rose in March, as across the EA, but with a difference in that here new fixed rates were unchanged and the increase was in variable rates.

Irish Housing Market Update

  1. The housing stock per head is still falling

Housing completions in 2021 amounted to 20,433 which is marginally down on the previous year and lower than the prepandemic figure of over 21,000 in 2019. This means that the housing stock is rising by around 1% a year and as such below the growth in population so the housing stock per head is falling, and has been declining since 2008.Planning permissions are running at around an annual pace of 40,000 and although not translating on a consistent basis into actual builds we expect completions to pick up strongly this year, to 25,000 and as such outpace the rise in population.

2.Employment growth is very strong

Housing demand is driven by household income growth , in turn strongly impacted by changes in employment. Ireland is again close to full employment with the vacancy rate at record levels .The Government’s fiscal support during the pandemic helped support the housing market by preventing a fall in household incomes, and employment in professional and other higher income occupations continued to rise.

3.House price growth is in line with fundamental models

There are various approaches to modelling house prices and we prefer a simple fundamental model comprising household income , the housing stock per head and real mortgage rates.The model tracks actual prices fairly well and does not point to a fundamental overvaluation (prices are actually modestly below fair value in the model ) and values should be rising given a combination of weak supply and rising employment and incomes. The predicted rise in 2021 was 6.7% (it is the annual average ) against the 8.3% outcome as per the CSO residential property price index . For 2022 the forecast is 10.0% which given that price inflation ended 2021 at 14.4% implies an end-2022 figure of around 6%, with the deceleration largely due to our expectation of a significant increase in housing supply.

4. Mortgages are still affordable relative to the long term trend.

The average new mortgage for house purchase in 2021 was just under €250,000 which assuming a 25-year term equates to €1150 a month given the average mortgage rate last year. That is actually well below the average monthly rent nationally and on our affordability model amounts to 26% of gross income. The long term average (going back to 1975) is 28.5% so on that basis affordability is by no means stretched, although the issue for many is accessing a mortgage and a property to buy. It is also noteworthy that the average loan to value appears to be falling, meaning higher deposits from buyers, no doubt reflecting the Help to Buy scheme and the scale of ‘forced’ savings during Lockdowns.

5. New Mortgage lending to rise to €13.6bn this year

Gross mortgage lending amounted to €10.5bn last year according to data from BPFI, which was over €2bn up on the previous year and the strongest annual figure since 2008.Switching has picked up but most lending is for house purchase, amounting to €8.6bn, with two-thirds of that going to First Time Buyers. In the coming year we expect the forecast rise in house completions to drive a significant increase in the number of mortgages for house purchase ( to 42,000 from 35,000 last year) which allied to higher house prices yields a figure of €11.4bn for house purchase. Total mortgage lending is projected at €13.6bn.

6. Net lending is positive again but weak

Perhaps the most striking aspect of the current house price boom is that it is not being driven by credit, as on past occasions.This in part reflects the impact on leverage from the Central Bank’s mortgage controls, with the average Loan to Income at 3.3 which is the lowest in the euro area. Institutional buying is also significant but households are repaying debt as mortgages from the previous boom mature. The result is that net mortgage lending last year rose by just €850m, or 1.2%, which is well below the euro average figure of 5.4%. The projected increase in gross lending should help to boost the net figure in 2022 and we expect an end-year increase of 3.5%.

7. Rent rises also unsurprising

Using data from the CSO on private rents actually paid, last year saw a marked change in the market; rents nationally were falling on an annual basis in the first few months of the year before picking up sharply to an 8.4% annual increase by December. Again this is in line with our fundamental model, driven by employment and the housing stock, although our projected rise in house completions does feed through into a slowdown in rental growth in 2022, to 4% by year-end. This may be an underestimate though, as it would appear that the supply of rental properties is being adversely impacted by rent controls

8. Mortgage rates may rise.

85% of new mortgages are on a fixed rate and that trend has been in place for some time now, so impacting the stock of outstanding mortgages and making the market less sensitive than it was to changes in ECB rates. Nonetheless , just over half the existing mortgage debt in Ireland is on a variable rate, with the majority of those loans on a Tracker rate, which moves with the ECB’s refinancing rate.The prospect of an increase in the latter has increased as the ECB now appears inclined to tighten monetary policy this year although any initial moves would be via the deposit rate, which would impact new variable rates and new fixed rates. Nothing is set in stone as yet but it is likely that borrowers will face higher rates for new loans by the autumn or earlier, with Tracker rates moving up in 2023.

ECB opens door to rate increases.

Today’s ECB press conference (3 Feb 2022) marked a very significant change in ECB rhetoric, and it now looks far more likely that interest rates are on the way up; the market is currently priced for short term rates to be 0.3% higher by year-end and to turn positive by the spring of 2023.

That may or may not materialise but it is clear that the recent upside surprises to EA inflation has shaken the ECB’s previous belief that inflation would fall steadily in the early months of 2022. That view had prompted President Lagarde to state that it was ‘highly unlikely’ that rates would rise at all this year, but when asked she refused to reiterate that line, arguing now that ‘the situation had changed’ and that the ECB was data dependent. Lagarde also noted a few times that the unemployment rate in the EA had fallen to a historic low of 7%, thus raising the risk of ‘second round’ effects i.e. higher wages feeding into higher costs and prices.

Inflation is now deemed subject to ‘upside risks’ and given that and the overall hawkish tone it was odd to see that the monetary policy statement still included the line ‘the Governing Council expects the key ECB interest rates to remain at their present or lower levels‘ (my italics), presumably an oversight.

The March meeting now assumes greater importance, as that will include updated Staff forecasts. The inflation projection for this year will almost certainly be revised much higher(it was 3.2% in the last forecast) but the crucial factor will be the figure for 2024, which was 1.8% and hence below target but could now move up to 2% or above.

The timing of any rate increase is complicated somewhat by the present ECB commitment to end QE before raising rates. The PEPP ends next month but as it stands there is no end-date fixed for net asset purchases, which from October are set at €20bn a month. So to raise rates this year the Governing council would first have to terminate net purchases.

What does this mean for Irish mortgage rates?. Any initial moves by the ECB would be through the deposit rate, which would affect market rates and hence new variable mortgage rates and new fixed rates. The refinancing rate, which affects Tracker mortgages would be unchanged initially but would probably rise as well as we move into 2023. This is not set in stone and weaker economic growth or a spike out in government borrowing costs might change things, but as its stands it appears the ECB is likely to tighten monetary policy sooner rather than later.