Produced by the Economic Research Unit January 2013 A quarterly analysis of trends in the Irish economy Domestic demand shows signs of life Group Chief Economist: Dan McLaughlin 0.8% rise in GDP still expected for 2012 1.5% growth forecast for this year The modest 0.2% rise in third quarter Irish GDP has not prompted any change to our 0.8% estimate for the year as a whole but was significant nonetheless, in that domestic demand recorded annual growth for the first time since early 2008. The increase is unlikely to prevent a fall in domestic spending for 2012 as a whole but lends some support to our view that domestic spending will stabilise this year and hence cease to be a negative drag on GDP. Consumer spending appears to have picked up modestly in the second half of 2012 and although that was not enough to offset weakness earlier in the year it gives more credence to the view that consumer spending will be flat in 2013, with household incomes supported by lower inflation, a stabilisation in employment and a modest increase in earnings, although still dampened by falling transfers and rising taxes. Business spending is expected to rise again after a recovery in 2012 and although construction is expected to decline it may be very modest. The more positive signs in terms of domestic activity, including a rise in new mortgage lending and more evidence of stability in house prices, has to be tempered by the disappointing performance of the external sector, with merchandise exports particularly weak. This owes a lot to a sector specific factor in pharmaceuticals but the weak outlook for the European economy implies downside risks for exports as a whole in 2013. We do expect a marginal pick up in export growth, nonetheless as the pharmaceutical impact fades, but disappointment on that front would be very negative for growth as a whole as exports are so large relative to GDP. Irish GDP Page 2 GDP growth at 0.8% in 2012 and 1.5% this year Inflation Page 4 Sharp decline in recent months The Labour Market Page 5 Unemployment rate ends year at 14.6% Exchequer Finance Page 6 2012 deficit emerges below expectation Funding the Exchequer Deficit Page 7 Issuance off to positive start Contact Us Page 8 Overall, we still expect 1.5% GDP growth in 2013, but with a somewhat different composition, with the contribution of domestic demand revised up and net exports down. The income of Irish residents, measured by GNP, probably rose faster than GDP last year following strong growth in income earned on Irish investments abroad and we estimate GNP growth of 2.3%, although slowing to 1% in 2013. Last year also threw up a record Balance of Payments figure, which we estimate at 5% of GDP, which highlights how far the economy has come in rebalancing from the excesses of 2006 and 2007. The Exchequer finances have similarly come a long way, and the 7.5% deficit target for this year now looks more attainable given the stronger than expected revenue performance at year-end, although the forecast cash deficit for 2013 is now higher than the 2012 outturn.
Irish GDP GDP growth at 0.8% in 2012 and 1.5% this year Domestic demand leads third quarter growth The Irish economy, as measured by real seasonally adjusted GDP, expanded by 0.2% in the third quarter and upward revisions to the first two left the annual growth rate in Q3 at 0.8%. The high frequency data available for Q4 paints a mixed picture retail sales probably grew and the services and manufacturing PMI s continue to point to expansion but industrial production may have fallen sharply in the quarter but we are inclined to retain our 0.8% growth forecast for 2012 as a whole. The third quarter data was unusual in that growth was driven by domestic demand with the external sector exerting a negative influence on GDP, a reverse of the usual pattern seen over the past few years. Indeed, domestic demand grew on an annual basis for the first time since early 2008, providing some support to the view that the Irish economic recovery, which has been slow, uneven and dependent on one sector, will now become more broadly based and hence more likely to generate some employment growth. and 2012 growth composition now looks a little different Capital spending provided the main stimulus to growth in the third quarter, rising by 8.5%, with a surge in spending on machinery and equipment offsetting a further decline in construction. The former is particularly volatile on a quarterly basis, (aided by large swings in aircraft orders) but is now in positive territory on an annual basis, and we therefore expect spending on machinery and equipment to rise by 12% for 2012 as a whole. Construction output is likely to fall by 10%, however, which would be the smallest decline in four years but would still offset the rise in business spending to leave the total flat for the year. Consumer spending also grew in Q3, albeit by a modest 0.5% after a 1.9% fall over the first two quarters, and we are revising our consumption forecast for 2012; we now project a 1.4% decline, from over 2% previously. Recent data revisions point to a smaller decline in employment in 2012 than previously thought and average earnings may have risen marginally, which alongside a fall in transfers and a rise in taxes still implies a fall in household disposable income, but only a modest one. Government spending fell marginally in the third quarter and probably declined by some 4% for 2012 as a whole, with the result that domestic demand still declined by 1.8%, although this was strongly coloured by events in the first half of the year. with exports losing momentum The conventional view of Ireland is of an economy experiencing a significant boost to competitiveness and experiencing an export-led recovery and in that sense the Q3 data threw up some concerns. Merchandise exports fell on an annual basis for the second consecutive quarter and total exports only grew by a seasonally adjusted 0.3% following a decline in Q2. Specific factors affecting the pharmaceutical sector are at work but the international backdrop, particularly the UK and continental Europe, may also be having a negative impact. Service exports are holding up however, albeit also slowing on an annual basis to 7.6% growth in Q3 although we now expect a less positive contribution from external trade to GDP in 2012, with export growth of 2.8% against import growth of 0.5%. Consequently, our GDP forecast is unchanged but domestic demand is now making less of a negative contribution, and net exports less of a positive contribution. For 2013 we retain our 1.5% GDP growth forecast, with the five-year fall in domestic demand finally coming to an end on an annual basis, although we still expect only a flat reading. Spending on machinery and equipment may continue to rise, so offsetting a forecast modest fall in construction, and consumer spending may stabilise, following some stabilisation in employment and a marginal increase in earnings, although offset by the expected fall in transfers and another rise in the tax burden. Consequently, the forecast rise in GDP is again dependent on net trade which highlights the economy s vulnerability to external events now that exports exceed the level of GDP. 2 Bank of Ireland Global Markets
Nevertheless, we expect some recovery in merchandise exports as the industry specific shock seen in 2012 fades, and pencil in a 3.5% rise, with imports picking up to 2.6% growth on the back of stronger domestic demand and the rise in exports. GNP growth outpaced GDP in 2012. Some commentators prefer to use GNP as a measure of Irish national income, although its volatility on a quarterly basis is extremely high. That was again evident in the Q3 data, as GNP fell by 0.4% in the quarter but rose by 3.7% on an annual basis, following a 3.6% annual rise in Q2. GNP is the income of Irish residents and adjusts the output measure (GDP) by adding any income earned on Irish investments abroad and subtracts income paid abroad on investments held in Ireland. The latter exceeds the former by a substantial margin but of late the income on Irish assets abroad has grown at a faster pace, hence boosting GNP growth relative to GDP. Consequently, we now expect GNP to have risen by 2.3% in 2012 following a 2.5% decline the previous year, but to lag GDP in 2013, rising by 1%. The strong performance of income inflows alongside the strength of service exports (which now exceed merchandise) has boosted Ireland s current account on the Balance of Payments, with surpluses in excess of 3bn recorded in both Q2 and Q3. Consequently, we now expect the annual BoP figure to show a surplus of over 8bn or 5% of GDP, compared with a deficit of a similar magnitude in 2007 and 2008. That change is a useful indicator of how significant has been the rebalancing of the Irish economy in a relatively short period of time. Real GDP (% change) 2011 2012 (e) 2013 (f) Personal Consumption -2.4-1.4 0.0 Government Consumption -4.3-4.1-3.0 Capital Formation -12.6 0.0 4.0 - Machinery & Equipment -2.6 12.0 10.0 - Construction -15.8-10.0-2.0 Stocks (% of GDP) 0.1 0.1 0.0 Exports 5.1 2.8 3.5 Imports -0.3 0.5 2.6 GDP 1.4 0.8 1.5 GNP -2.5 2.3 1.0 3 Bank of Ireland Global Markets
Inflation Sharp decline in recent months CPI inflation to average 1.2% this year Irish inflation, as measured by the consumer price index, has fallen sharply of late, declining to an annual 0.8% in November from 2% in August. Base effects were a factor but the index has fallen for three consecutive months and by a cumulative 0.6%. Energy prices rose marginally over that period and the fall in mortgage interest payments was very modest so the decline in prices was largely due to a fall in services. The indirect tax increases announced in the Budget will probably push prices up again in December but inflation will still end the year near to 1% and will therefore average 1.7% for 2012, against 2.6% in 2011. Inflation was boosted in early 2012 by a combination of higher energy prices and a two percentage point increase in the top rate of VAT so the annual inflation rate may well slow further in the first half of 2013 in the absence of an energy shock. Base effects from there on may lead to some modest reacceleration but for the year as a whole we expect CPI inflation to average 1.2% and hence provide a significant support for real incomes. Inflation as captured by the HICP measure is less volatile than the CPI primarily because it excludes the mortgage interest component. Consequently it did not benefit from the fall in mortgage rates last year and HICP inflation is likely to average 1.9% in 2012, up from 1.2% in 2011. with a similar HICP figure. Prices have also fallen in the three months to November on the HICP measure and the annual inflation rate has slowed sharply, to 1.6% from 2.6% in August. Again, the Budget is likely to push the index up for December but the same factors as for the CPI will be at work in the early months of 2013, so taking annual inflation lower. For the year as a whole we forecast HICP inflation at 1.3% and hence below the expected euro figure of 1.8%. CPI Inflation (annual change, %) 2012 2013 Q1 2.2 1.1 Q2 1.8 0.9 Q3 1.7 1.0 Q4 1.1 1.9 Annual 1.7 1.2 HICP 1.9 1.3 4 Bank of Ireland Global Markets
The Labour Market Unemployment rate ends year at 14.6% Data revisions show employment decline has slowed The 2011 census revealed an Irish population that was some 96,000 higher than previously thought which prompted a revision to the net migration estimates from 2006, the date of the previous census. The CSO has now also adjusted its estimates for the numbers in employment and in the labour force, to take account of the census data, and the results change the labour market picture from that previously perceived. Employment is still falling but the pace of decline is now much slower. The numbers at work in the third quarter, at 1.84 million, is just 4,000 down on the same quarter a year earlier, or 0.2%, with job losses in construction, manufacturing, transport and the retail trade just offsetting job gains across a range of other industries. The decline in the labour force has also slowed appreciably on these latest figures, falling by an annual 8,000 in the third quarter, or 0.4%, to 2.17 million, with the result that the number unemployed fell slightly from a year earlier, from 328k to 325k. The latter figure emerged at 318k on a seasonally adjusted basis, giving an unemployment rate of 14.8% in the third quarter. and the unemployment rate fell from a 15% high. Since then the monthly unemployment rate estimates have fallen marginally, to an average 14.6% in the fourth quarter and the same figure for December. The Live Register has also fallen for six consecutive months, to a 3-year low, which perhaps owes more to net emigration than to job creation. The economy is forecast to pick up momentum this year but employment growth is unlikely to materialise in any substantial way in the absence of a rise in domestic demand. Consequently, we are projecting a stabilisation of employment on average for 2013, which alongside a further modest fall in the labour force leads to only a marginal decline in the unemployment rate. Labour Market (annual averages 000) 2011 2012 2013 Employment 1849 1836 1836 Labour Force 2167 2155 2142 Unemployed 317 319 306 (% of labour force) 14.6 14.8 14.3 5 Bank of Ireland Global Markets
Exchequer Finance 2012 deficit emerges below expectation The 2013 Budget cut spending and raised taxes The Department of Finance expects the Irish economy to pick up momentum this year, projecting real GDP growth of 1.5% (against a 0.9% estimate for 2012) and a 2.8% rise in nominal GDP, taking it to 167.7bn. Despite this, the General Government deficit, the standard fiscal measure used in the EU, was forecast to rise to 8.9% of GDP in 2013 from a projected outturn of 8.2% last year, hence requiring another round of fiscal adjustments to hit the 7.5% deficit target agreed with the Troika. To achieve this, the Minister for Finance introduced new tax measures in the 2013 Budget, designed to raise 1.2bn, and cut exchequer spending by 1.5bn, which alongside carry-over effects and an increase in dividends from semi-state companies, brought the total adjustment to 3.5bn or 2.1% of GDP. That figure was as expected, although the breakdown involved more on the taxation side than previously indicated. The net result was a forecast current budget deficit of 9.6bn (from a projected 10.9bn for 2012) and a capital deficit of 5.8bn ( 4.9bn) giving a cash deficit or Exchequer Borrowing Requirement (EBR) of 15.4bn ( 15.7bn). The General Government deficit target duly emerged at 7.5% of GDP or 12.6bn. but exchequer deficit target now higher than 2012 outturn. In the event, tax receipts in December were much stronger than expected which alongside lower spending than projected left the 2012 EBR at 14.9bn or 0.8bn lower than forecast just a month earlier. This now makes the 2013 Budget figures more attainable (the implied rise in tax receipts is now 3.5% instead of 5%) but also means that the EBR target for this year is now above the 2012 outturn. Similarly, the 7.5% General Government deficit is now only marginally smaller than the likely 2012 outturn, which may be as low as 7.7% of GDP (it has yet to be finalised). Exchequer Finances ( bn) 2012 2012 2013 Budget Actual Budget (f) Current Expenditure 49.5 49.6 49.9 - Voted 40.5 41.5 40.2 - Non-voted 9.0 8.1 9.7 Revenue 38.3 39.5 40.3 - Tax 35.8 36.6 38.0 - Other 2.5 2.8 2.4 Current Budget Balance -11.2-10.1-9.6 Capital Balance -7.7-4.8-5.8 Exchequer Balance -18.9-14.9-15.4 General Government Balance -13.7-12.6 (e) -12.6 (% of GDP) (-8.6%) (-7.7% (e)) (-7.5%) 6 Bank of Ireland Global Markets
Funding the Exchequer Deficit Issuance off to positive start NTMA raises 2.5bn against 10bn market target The NTMA raised 24.1bn in funding last year, with most of it ( 18.8bn) coming from the IMF ( 6.4n) and the EU ( 12.3bn). Bilateral loans pledged from the UK, Sweden and Denmark provided another 2.5bn, with the various national savings schemes (marketed to retail investors) raising 2.2bn. The agency also re-entered the bond market raising over 6bn gross and some 2bn net. The EBR outturn of 14.9bn meant that the NTMA overfunded by 9.2bn or 6.1bn if one takes account of the 2025 bond issued to IBRC in respect of the promissory note, with the result that balances rose to 24bn from 17.8bn at the end of 2011, with some 15bn of the former in cash. The average interest rate on the bonds issued to the market was 5.9% which compares with around 3.4% for official loans and as such it would make sense for Ireland to draw down the remaining sums available, amounting to over 11bn This compares with a projected funding requirement this year of some 21bn (the EBR plus redemptions) so the NTMA have an implied requirement of around 10bn if balances are untouched. Under new EU rules 55% of any new issuance has to include a collective action clause, implying that the NTMA will have to issue a new bond or bonds as part of any market issuance. The rally in Irish bonds over the past six months also makes issuance in general much more attractive from a cost perspective and the agency has already raised 2.5bn via a syndicated tap of the existing 5.5% 2017 at a yield of 3.32%. high debt burden implies vulnerability. The scale of Ireland s debt still makes it vulnerable to any setback in terms of economic growth. General Government debt amounted to 169bn in 2011, or 106% of GDP, and probably rose to around 192bn last year, equivalent to 118% of estimated GDP. Total debt will rise to over 200bn this year and the Department of Finance expect the debt ratio to reach 121%, albeit peaking there and declining modestly next year, reflecting a projected primary budget surplus and a forecast pick-up in economic growth. These figures take no account of any potential savings on a deal which would reduce the bank-related debt included in the General Government figure, but the prospect of the ESM taking a stake in the Irish banks looks increasingly remote and a change to the terms of the promissory note is proving illusive and would probably not have a significant impact on the debt total. 7 Bank of Ireland Global Markets
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