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.

Irish consumers cut spending

The US economy contracted for a second successive quarter in q2, so fulfilling one of the most common definitions of recession, although consumer spending there is still growing and the economy is around full employment. Growth in the euro zone, in contrast, has surprised to the upside in the first half of the year, contrary to expectations , in part due to a big rebound in tourism across France, Italy and Spain, although markets are still projecting a period of very weak or falling GDP which it is assumed will limit the degree to which the ECB can raise interest rates.

The future path of Irish GDP will largely depend on how the external sector performs and the composition of exports makes it less likely that a big decline there will materialise judged on the evidence from the Pandemic period. The labour market here also appears robust, although it is clear that households have retrenched in response to the surge in consumer prices since last autumn.

Indeed, we have seen two consecutive quarters in which real consumer spending fell; the decline in the final quarter of last year was modest, at 0.6%, but that was followed by a sharper fall in the first quarter of 2022, at 1.3%. Retail sales , a more timely indicator of household spending, did recover in the second quarter, rising by 2.2% in volume terms, but that was due to a big increase in April, as sales have actually fallen in nine of the past twelve months. Excluding the motor trade, retail sales also picked up in q2, albeit by only 0.5%, and again reflecting a strong April as sales fell in May and June by a cumulative 4%.

The annual change in the monthly retail sales data is volatile given the distortions due to Lockdowns last year but the fall in June was notably large, at 6.6%, with only two sectors recording positive growth- Bars and Chemists- so the squeeze on real household incomes is clearly biting. CPI inflation was probably unchanged in July at 9.1%, a welcome respite if true following five consecutive months of acceleration, and the ongoing fall in fuel prices offers some hope that we may be at or near the inflation peak. The scale of the weakness in retail sales may also prompt shops to offer more sales, so putting additional downward pressure on the monthly CPI but the big upside risk remains the broader energy picture, with European gas prices still rising and hence feeding through into higher home heating costs.Ireland may avoid a recession in terms of GDP but household spending and the High Street have not escaped.

ECB shreds Forward Guidance playbook and unveils OMT lite

The Covid pandemic prompted a massive fiscal response across the developed world and major central banks unveiled further monetary stimulus, which in the ECB’s case took the form of additional bond purchases (the PEPP) and the provision of long term funding to the banking system on attractive terms (TLTRO III). Central banks as a group were also of the view that the pick up in inflation through 2021 was ‘transitory’ and therefore did not require monetary tightening.

Inflation at the time of the ECB meeting last December was 4.9% and the Bank forecast an average inflation figure of 3.2% for 2022, with a fall back below the 2% target the following year. It did signal that the PEPP would end in March but that its maturing holdings would be reinvested till end-2024 while no end-date was set for its Asset Purchase programme. Reinvestments from the latter would continue for ‘an extended period’ after the first rate increase.

The invasion of Ukraine added further upward pressure on elevated energy prices, notably natural gas, and inflation in Europe and elsewhere consistently surprised to the upside, prompting the ECB to respond in June by signalling rate increases to come, albeit still buying bonds till the end of that month.A quarter point increase in ECB rates was pre-announced for the 21 July meeting, with another rate increase to follow in September, although the latter could be higher depending on the inflation performance. The Governing Council also anticipated ‘that a gradual but sustained path of further increases in interest rates will be appropriate’. The accompanying forecasts projected a gradual fall in inflation to 3.5% next year and 2.1% in 2024, with the decline due to  ‘moderating energy costs, the easing of supply disruptions related to the pandemic and the normalisation of monetary policy’.

Longer term market rates have moved higher in anticipation of monetary tightening , although expectations have been volatile , fuelled by fears of a global recession; 5-year euro swap rates spiked to 2.20% a month ago, from zero in early February, but have fallen back since, declining to 1.5% before a recent rise to 1.75%. Government bond yields have also risen but not in a uniform manner, with Italy in particularly seeing a significant widening in spreads to Germany. The ECB views this as ‘fragmentation’ and promised to announce a policy tool to counter it on top of using PEPP reinvestments in a ‘flexible manner’, meaning using the proceed of an Irish bond maturity, for example, to buy more Italian debt.

Today’s ECB meeting was surprising on a number of fronts. First, President Lagarde announce a 50bp rise in ECB rates instead of the signalled quarter point, citing the recent inflation data and the weakness of the euro. Second, forward guidance on rates has been abandoned, with a ‘meeting-by-meeting approach to interest rate decisions’, meaning that the September rate decision is now open. ‘Further normalisation will be appropriate’ but she refused to be drawn on what a ‘normal rate’ might look like. Gone also was the previous reference to maintaining ‘ optionality… gradualism and flexibility in the conduct of monetary policy’ although one could argue they were mutually exclusive anyway.

The new anti-fragmentation tool duly appeared with yet another acronym – TPI or Transmission Protection Instrument. This has no set limits and can buy public sector debt from 1-10 year maturities ‘to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area’. Eligibility is conditional though on a given country pursuing ‘ sound and sustainable fiscal and macroeconomic policies’ including complying with the European Commission’s country specific recommendations on fiscal policy and recovery and resilience plans for the Recovery and Resilience Facility.

So in effect the ECB is becoming an enforcer of the EU’s fiscal rules, as was indeed envisaged a decade ago with the creation of Outright Monetary Transactions (OMT).. That required strict fiscal surveillance under an ESM adjustment programme and was never actually triggered so this could be considered OMT lite, with the ECB again as fiscal enforcer but with longer maturity purchases ( OMT was out to 3 years).

One area left vague in the TPI announcement was how the ECB will ‘sterilise’ any bond buying to avoid raising its existing bond holdings or adding to the already huge excess liquidity in the system. That detail will be very significant for the market and as yet there has not been a significant reaction in terms of the euro or interest rate expectations.

Irish Budget change does not make sense

The Irish Government has announced that the 2023 Budget will now be delivered on 27th September, two weeks earlier than planned. This makes little sense and far from bringing it forward there is a strong argument for pushing it out to later in the year, given the degree of uncertainty about energy prices and the risks of a global recession.

In fact ,delivering the following year’s budget in early October , let alone September, risks major forecasting errors, as illustrated in the 2022 Budget. The Government projected tax receipts in 2022 of €70.2bn, or 6.2% above the expected end-2021 outturn of €66.1bn. In the event the latter emerged at €68.4bn, so implying tax growth of only 2.7% in 2022. As the year unfolded a combination of higher real growth than predicted, much stronger employment gains and the spike in inflation rendered redundant the original Budget projections. In April the Government revised the tax target up by €5.5bn, to €75.8bn, and slashed the projected Exchequer deficit from €7.7bn to €1.1bn.

That forecast now looks wrong given the Exchequer figures to end-June and the Summer Economic Statement notes that the budget will probably be in surplus this year and next, albeit without providing any detail (if so Ireland will probably be alone in the euro area in not running a fiscal deficit). Tax receipts are 25% ahead of the same period last year while non-tax revenue is also much stronger than budgeted, including a transfer from the Central Bank of over €1bn and €650m from the sale of bank shares in AIB and BOI. As a result the Exchequer is running a surplus year to date of €4.2bn, and the NTMA’s cash balances (from overfunding) have risen to €35bn.

The Government has already taken some measures to partially offset the impact on households of the surge in energy prices, including a temporary cut in excise duty on fuel, and now intends to spend €400m more than originally budgeted in 2022. The Minister for Finance cannot put tax receipts from this year in a drawer and produce them in January so any tax or spending measures in the 2023 Budget are dependent on forecasts for tax growth next year.

The exact sums the Government plans to spend are clouded somewhat by the distinction made between ‘core’ gross voted spending, both current and capital, and total voted spending, as the latter has of late included one-off’ items largely related to Covid supports. These one-off sums are projected at €7.5bn this year , which alongside a ‘core’ total of €80.5bn gives a total gross voted spend of €88bn At end-June spending was €38.5bn, implying a spend of some €50bn in the next six months if the plans are met.

The Government had announced that it intended to limit the annual growth in ‘core’ spending in the medium term to 5%, implying a rise in 2023 of €4bn. That was predicated on inflation of around 2% which is clearly no longer plausible and the rise now planned for next year is €5.3bn, or 6.5%, taking the total to €85.8bn. Some €3bn of that has already been allocated leaving the balance to be decided on Budget day, with a tax package of €1.1bn also flagged.

What matters for the overall Budget arithmetic is total spending and there the planned rise is much lower, at €2.3bn, taking the total to €90.3bn, which explains why a Budget surplus is expected. The ‘one-off’ spending component is projected to fall to €4.4bn from €7.5bn as Covid supports dwindle, with the bulk of the total now a ‘Ukraine Humanitarian Contingency’.

The 2023 Budget is billed as a ‘cost of living’ budget, with extra sending and tax reductions to help cushion some of the impact of higher inflation, but those will come into effect next year. Moreover, as they have already been signalled there is no longer an ‘announcement effect’ in the Budget, whenever it is held. The Budget will include detailed economic forecasts and of course a prolonged period of high inflation and/or a marked global slowdown could again derail the Budget assumptions.

Can the ECB raise rates aggressively given the Fragmentation risk?

The Euro has a fundamental flaw in that member states have fiscal sovereignty but not monetary sovereignty, which is the exclusive preserve of the ECB. Unlike say the UK or the US, EA governments cannot print money in order to fund fiscal deficits if markets are unwilling to buy that debt. As we saw in 2010, that inability precipitated a full-blown existential crisis for the single currency, which was eventually resolved by a changing of the guard in Frankfurt and Draghi’s ‘whatever it takes’ pledge a decade ago..

That involved the creation of bond buying programme known as Outright Monetary Transactions (OMT) designed to buy the bonds of member states where yields were deemed too high and therefore impairing the full transmission of monetary policy-‘fragmentation’ in the ECB lexicon. Access to OMT was to be at a price though-fiscal discipline, with member state eligibility dependent on fiscal retrenchment.

In the event OMT was never used but in 2015 the ECB embarked on QE, buying the bonds of all member states in an effort to combat the risk of deflation. The ECB now holds €5,000bn in bonds ‘for monetary purposes’, about 41% of EA GDP, including €1,700bn from its PEPP programme introduced in 2020. QE is essentially an enormous Swap transaction, in that the ECB receives fixed interest rate coupons on the bonds it holds while paying a floating rate to banks on their reserves, created by the ECB. That makes the ECB vulnerable as rates rise on those reserves.

The ECB is now faced with an inflation problem, which has accelerated far faster than most expected,consistently exceeding ECB expectations. Indeed, in last week’s staff forecasts, inflation was expected to peak in May at 7.5% but a footnote to the forecast acknowledged that the May figure (released after the forecast cut-off point) had been 8.1%, with the expected average for the year now seem as above 7%.

The Bank has now indicated it will tighten policy by raising rates, starting in July and then September, but had already committed to reinvesting PEPP holdings till end-2024, with the €3,300bn QE holdings also reinvested, this time for an ‘extended period’ after rates had started to rise. So it is still injecting huge liquidity into the monetary system while raising the cost of credit.

The prospect of higher short term interest rates has pushed up longer rates, as one might expect, but not evenly across the EA. German 10 year bonds currently yield 1.60% from -0.40% six months ago, a rise of 200bp, while Italian yields are now up at 4%, having risen by 310bp over the same period. Italian debt amounts to 150% of GDP and so a prolonged period of yields that high, or even higher, alongside limp growth, will push the debt burden up in the absence of much tighter fiscal policy. The latter is difficult politically at the best of times but more so now in the face of calls for much greater support for households struggling with the explosion in energy costs. Ireland seems to be out of the firing line, in that the spread with bunds has only increased by around 25bp, with the yield at 2.30%.

  How will the ECB combat fragmentation? Initially via the PEPP it would seem, with Lagarde emphasising flexibility in reinvesting the existing holdings across jurisdictions. Further, we are told ‘ the ECB will deploy either existing adjusted instruments or new instruments that will be made available’ It’s hard to see what other instruments could mean other than bond purchases (the OMT or an expanded PEPP?) which in effect would amount to intervening when yields have breached some target level. Deciding on that target is another issue of course but would in any case mean the ECB would be trying to control both short term rates and longer term rates.

There is also the issue of legality. The ECJ deemed QE as within the ECB’s mandate but there are fresh challenges to the PEPP, which does not have issuer limits. A clear peak in inflation over the next month or so might help to calm things down but the fragmentation issue raises the question of whether the ECB can tighten aggressively if in doing so it risks triggering another full-blown euro crisis.

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.

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.

Measuring Irish Inflation

Eurostat publishes inflation rates for the EU and the euro area each month and also issues a flash estimate for the EA , normally around two weeks before the final release. The flash figure now includes all EA member states, so an estimate for Ireland is available ahead of the official release here by the CSO.

The estimate is for the Harmonised Index of Consumer prices (HICP) , the official EU measure , which can differ from the domestic measure as used by the respective member states. For example, German inflation in April was 7.4% on their Consumer Price Index (CPI) against 7.8% on the HICP measure.

Most CPI are similar in terms of general components but differ in regard to measuring specific items, notably housing costs. The idea of the HICP is to use a standard methodology , so some items included in the CPI may be excluded from the HICP and this will also impact the component weights.

In Ireland’s case the CPI has a number of largely service items excluded from the HICP, amounting to over 6% of the CPI. These include the Local Property Tax, motor and dwelling insurance, motor tax and building materials. The most significant exclusion though is mortgage interest which has a weight of 2.76% and that component largely explains any significant difference in the two indices over time ,although that has not been a feature in recent years.

For example, the annual inflation rate in March on the CPI reading was 6.7% against 6.9% on the HICP measure. Two components,Housing and Transport, made a 5.2 percentage point contribution to the CPI (i.e. accounting for 78% of the total inflation figure) while the corresponding contribution to the HICP was 5.3 percentage points or 76%.

The difference can be sizeable though in periods when the ECB is changing its policy rates. For example, mortgage rates plunged through 2009 and Irish CPI inflation that year was -4.5%, against -1.7% on the HICP measure. As we now appear to be on the cusp of a tightening cycle from the ECB it is likely that CPI inflation will be higher than the HICP equivalent in the next few years as variable mortgage rates are still the dominant factor in outstanding mortgages here, despite the popularity of fixed rates in new mortgage loans.

The CPI is the ‘official measure of inflation for Ireland’ according to the CSO so in that context it is curious that rent controls last year were initially linked to the HICP and not the CPI, with the former not capturing any change in mortgage costs. The surge in inflation in 2021 prompted a change anyway, with the limit at a max of 2% or the HICP inflation rate if lower, which implies a significant fall in real rents given the inflation outlook, particularly if using the CPI as deflator.

Tax surge transforms Irish fiscal outlook

The 2022 Budget, delivered last October, projected a €7.7bn Exchequer deficit , largely due to high capital spending by the State, with a capital deficit of €11bn offsetting a €3.3bn current budget surplus. The projections were predicated on real GDP growth of 5.0% and price inflation of 2.2%, with tax receipts forecast at €70.2bn, which implied a very modest rise of 2.6% on the 2021 out turn.

Tax receipts grew by by an annual 32% in the first quarter of 2022, so it was clear that the Budget forecast was redundant, in part because inflation was much higher than envisaged, so boosting expenditure based taxes and income tax. The Department of Finance normally publishes in February a monthly profile of expected tax receipts but that has not appeared, also indicating that a significant revision to the initial fiscal outlook was likely. That has now duly emerged in the form of the Stability Programme Update (SPU) which is mandated each April for EU member states.

Tax receipts for 2022 are now projected at €75.8bn, which is €5.6bn above the Budget forecast and 11% higher than the 2021 out turn,reflecting much higher than expected receipts from Income tax, VAT and notably Corporation tax, which yet again has surprised to the upside. The only heading seeing a fall is Excise , due to the cut in duty on fuel. Non-tax receipts are also now above the initial target while current spending is broadly as planned, so giving a current budget surplus of just under €10bn. Capital spending is expected to be larger due to higher prices but offset by stronger capital receipts (reflecting the sale of bank shares by the State) leaving the capital deficit marginally lower than planned at €10.8bn.The net result is a projected Exchequer deficit of just €1bn, and a broader General Government deficit of €2bn or 0.4% of GDP (the initial target was €8.3bn , 1.8% of GDP).

The outlook for Ireland’s debt also looks even more positive in these new projections even though the debt dynamics were already favourable given that the interest rate on the debt is substantially below the growth rate of GDP. In 2022, for example, the economy is now forecast(in the SPU) to grow by 11% in nominal terms against a 1.5% interest rate on the debt, which leads to a large fall in the debt ratio, to 50.1% from 55% ,as the primary fiscal budget (the actual balance excluding debt interest) is actually in surplus. The latter is forecast to increase out to 2025, which helps to generate a debt ratio of under 41% by that year.

In fact some of the commentary on the debt interest bill is misleading, as it is projected to fall, not rise, declining to €3bn in 2025 from €3.6bn this year. This may seem counterintuitive given the recent rise in Irish bond yields (the 10 yr yield is currently at 1.45%) but the interest bill is largely determined by the cost of new bond funding (largely at a fixed rate) relative to the interest rate on the maturing debt. From 2023-25 the coupons on the maturing bonds range from 3.4% to 5.4% so it would require much higher current rates (and much higher borrowing) to prevent an ongoing fall in the interest bill, although that does start to reverse from 2026 as bonds issued in the very low rate environment start to mature.

These forecasts may not emerge as planned of course but as it stands Ireland is set to run a very large current budget surplus and an overall budget excluding debt payments also in surplus, which alongside a falling debt ratio does not support the view that the debt is a big issue.

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%.