Irish GDP growth to slow to zero this year and Fiscal outlook cloudier than appeared.

For some time now Irish exports have grown at a double digit pace, even during the Pandemic period, seemingly immune to cyclical developments in the global economy, and as such driving stellar growth in GDP, which averaged 9.2% a year between 2017 and 2022.. Chemicals and Pharma were key in that period, but there was also a remarkable rise in goods produced elsewhere but owned by Irish based entities and as such classified as an Irish export. These appear to be largely ‘machinery and equipment’ and generally thought to be semi-conductors for phones and made in China. The impact of this outsourcing is significant; in 2022 total Irish merchandise exports as per the national accounts amounted to €354bn, with goods produced here at €208bn or less than 60% of the total.

That long trend growth in exports came to a halt in the final quarter of last year and exports fell again in the first and second quarters. The fall in merchandise exports was particularly large in q2, at over 10% in the quarter in value and volume, so driving a 4.1% fall in total exports (including services) . Yet merchandise exports produced in Ireland actually rose marginally so the decline was due to outsourced exports, with goods for processing down €15bn or 58%. This may be company specific or due to issues in China itself and as such exports may rebound to some degree but that is uncertain and we have cut our export forecast to zero for the year.

We now expect domestic demand to contract by over 1%, with an 8% fall in investment spending offsetting growth in consumer spending and government consumption. Construction is forecast to fall by 3%, including a decline in housebuilding, with a 10% contraction in spending on machinery, equipment and Intangibles.The latter is strongly impacted by multinational R&D and is excluded from the CSO’s measure of modified domestic demand, which we expect to grow by 1.5%, supported by a 3% rise in consumer spending, which is considerably weaker than the 9.4% recorded last year, following a significant upward revision. The corollary was a significant downward revision to the savings ratio, although still running at a double digit pace.

Real pay per head is falling but aggregate real income for households is now rising again , thanks to the strength of employment growth. Inflation has been slower to fall than many anticipated, with the CPI measure at 6.3% for August. That is well down from the 9.1% peak but the fall was largely due to base effects from energy prices (although food inflation is slowing sharply) with service inflation now the driver, including a significant rise in mortgage costs, which added 1.4pp to the latest annual figure. Moreover fuel prices have started to rise again, so we expect only a modest fall from here to year-end and an annual average figure of 6.5%. The Government and the Central Bank now use the HICP measure in their forecasts, which excludes mortgage interest and is consequentially lower, and we expect that to average 5.6% this year. Both measure should fall gradually next year on base effects alone absent another energy shock.

We have emphasised for some time now that Ireland is at full employment, with the unemployment rate now trending around 4%. Employment growth has been strong, despite some high profile redundancies in part of the ICT sector, with a 78k rise on average likely this year, or 3.1%, broadly matched by a similar increase in the labour supply. That strength has been crucial in preventing a sharper correction in the housing market and in mortgage lending for purchase than seen to date, despite the rise in mortgage rates, and helped support tax receipts, with income tax up an annual 8.2% in August.

That heading is slowing though as indeed is tax revenue overall, to 6.6% in August from double digit growth rates seen earlier in the year. Some headings are flat (excise duty,impacted by the cut on fuel duty) and others well down on the year, including capital taxes and stamp duty ( affected by weak commercial property sector). VAT is still strong, rising by over 11%, but again is slowing, no doubt impacted by the fall in inflation. The big change though is in corporation tax, which is still well ahead of last year , by over 7%, but was growing by over 50% at one stage. One might expect the weaker export performance to eventually feed through to multinational profits and in that sense some softening is to be expected.

The upshot though may be that the Budget surplus expected this year could be lower than expected. Moreover the €65bn cumulative surplus flagged in April over the period 2023-2026 may not emerge as predicted, due to higher spending than initially projected and to some softening in receipts, including no transfers from the Central Bank. which will probably record losses.Employment growth too is likely to slow with a knock-on effect on income tax receipts and VAT.