Domestic spending falls but exports spur double digit Irish growth in First quarter

Ireland’s economic performance in the first quarter of the year was marked by a dichotomy between domestic spending and exports; the former fell, no doubt impacted by the acceleration in inflation, while the latter grew strongly. The net impact was a double digit rise in GDP,which also implies that the consensus growth figure for the full year, currently around 4%, is too low.

The monthly data on industrial production and Irish trade had implied a strong quarterly reading in exports, although the national accounts figure also includes output manufactured offshore, largely in China, so adding a degree of uncertainty given the Lockdowns there. In the event the outsourcing component was lower than of late but not enough to prevent a 5.2% quarterly rise in the volume of exports. which boosted GDP by 7.5 percentage points. There was also an unusually large contribution from stock building of 3.8 percentage points and these two components largely explain the 10.8% surge in q1 GDP.

The consensus view this year envisages strong growth in consumer spending, in part fuelled by a big fall in the savings ratio, although we are skeptical on that issue. The upside surprise in inflation may also be having an impact though, and personal consumption actually fell in volume terms in q1, by 0.7%, following a 0.5% decline in the final quarter of last year. Government consumption also contracted in volume terms, by 0.4%, while the other component of domestic demand, capital formation, plunged by 39.5%, driven by another large fall in spending on Intangibles . This component is extremely volatile on an annual let alone quarterly basis but is broadly GDP neutral as most of it is also captured as a service import (which reduces GDP) . Consequently that component fell sharply in q1 , by 19%, with total imports falling by 12%.

The annual growth rate of GDP picked up to 11% in the first quarter, from 9.6% , and as such means that Ireland would have to record a recession in the coming quarters to leave the average for the year anywhere near the 4% consensus. GDP growth forecasts will therefore probably be revised up in the near term, although domestic demand projections are likely to be revised down, notable consumer spending.

Irish GDP growth to slow to 4.5% this year, with inflation seen at 5%

The Irish economy as measured by real GDP grew by 20% over the pandemic years 2020/21, expanding by 13.5% last year following a rise of 5.9% . The final quarter saw a substantial contraction, however, of 5.4% , and a combination of negative base effects over the first half of 2022 , much higher inflation and the negative impact of the Russian invasion of Ukraine on asset prices and economic activity has prompted us to reduce our forecasts for growth this year to 4.5%. That could prove optimistic if crude oil and gas prices spike higher , thus having a much more significant impact on real household incomes.

GDP growth last year was again largely driven by exports, recording a 16.6% rise including over 20% from merchandise exports. The latter includes contract manufacturing, goods produced abroad (mainly China) for an Irish domiciled company, and the impact of this production is now extremely large; total merchandise exports last year amounted to €283bn with €165bn actually produced in Ireland.

The export figure alone would have delivered GDP growth of 20% and that was partially offset by another large fall in capital formation , declining by 38% following a 23% contraction in 2020. Construction fell again , by 3.5%, although the decline in house building was modest, largely reflecting a Lockdown in the first quarter. Investment in machinery and equipment did recover strongly, up 24%, but that was swamped by another huge fall (55%) in Intangibles. The latter includes spending on R&D and Patents by multinationals and is broadly GDP neutral as it is also captured as a service import.Consequently total imports fell, by 3.7%, with a large decline in service imports offsetting a recovery in merchandise imports.

Consumer spending had fallen sharply in 2020, by 10.7%, and a recovery was expected, supported by the build up in ‘forced savings’ evident through the pandemic. In the event the recovery in consumer spending was relatively modest , at 5.7%, with the decline in the savings ratio rather less pronounced than some envisaged; the third quarter figure was 16.7% against 21% a year earlier. Government consumption growth (5.3%) was similar to that of households but in contrast slowed from the double digit pace of 2020.

Nominal GDP in 2021 grew by 13.1% to €422bn, so flattering the fiscal ratios; the fiscal deficit is now put at 2.1% while the debt ratio appears to have fallen to 56% from 58.4% in 2020 (the end-year debt figure has yet to be confirmed). GNP, which adjusts for profit and interest flows in and out of the economy, also grew very strongly in real terms, by 11.5%. The CSO also publishes a figure for modified domestic demand (which adjust for some multinational spending on headline capital formation) and that grew by 5.5% last year, although it excludes all exports and takes no account of how that demand is satisfied ( i.e. from domestic or imported output).

Base effects play an important role in any forecast for GDP and the carryover effect in 2022 is lower than we expected, as GDP fell by 5.4% in the final quarter of 2021, reflecting a substantial rise in imports. Capital formation also rose but export growth was weak and consumer spending actually fell. Given also that the growth surge seen in the first quarter last year is unlikely to be repeated we now forecast a substantial slowdown in Irish growth this year, to 4.5%. Exports, as always, will largely determine the GDP figure and we expect a much weaker trade performance given an expectation of slower growth in Europe and the US with supply issues evident in China. Building and construction ,in contrast, is forecast to recover strongly,growing by 12%, boosted by housebuilding, with a more modest increase expected in overall capital formation on the assumption that Intangibles grow after two successive annual declines.

Households will also face a much more difficult year, with real incomes eroded by much higher CPI inflation. That averaged 2.4% last year but spiked in the latter months of the year and into 2022, with the February figure at 5.6%. The surge in the CPI was largely due to two components (Housing +Utilities and Transport) and hence largely energy related but the most recent data showed the beginnings of a broader increase ( albeit also impacted by the minimum pricing on alcohol introduced in January) reflecting energy costs on producers, supply issues and the impact of the fall in the euro, notably against sterling. The March figure will capture another surge in fuel costs following the Russian invasion of Ukraine and we now expect inflation to average 5% this year, although this assumes a stabilisation in oil and gas prices and so the risks to that projection are to the upside. As a result we now expect consumer spending to rise by just 2% in real terms this year.

The Labour market reveals a more positive picture, with the total number employed surpassing 2.5 million for the first time in the final quarter of 2021, following an annual increase of 230,000.The unemployment rate is back down to around 5% and with a record vacancy rate Ireland is around full employment, with labour scarce and jobs plentiful. In 2022 we expect the unemployment rate to fall marginally to 4.8% , with employment growth of 115,000. The tightness of the labour market may also help to maintain weekly earnings growth at around 5% in 2022 (fro 4.8% last year).

On the fiscal side tax receipts have surprised to the upside relative to Budget projections in each of the past four years. Last year receipts grew by 20% and exceeded the initial Budget target by €8bn and this year (at end-Feb ) were still rising at a similar annual pace. The 2022 Budget envisaged a 2.6% rise in receipts by year end so a much lower deficit than projected is on the cards, with a large capital deficit offsetting a substantial current budget surplus . The Government may well revise the fiscal targets but also has the scope to take further action to offset the impact of higher energy prices on households, having already introduced a rebate on electricity bills and a (temporary) cut in excise duty on fuel at a total cost of over €800m. Nonetheless the fiscal deficit may fall below 1% of GDP, with the debt ratio declining to 52%.