Produced by the Economic Research Unit July 2014 A quarterly analysis of trends in the Irish economy Growth to accelerate Strong start to 2014 Recovery becoming more broad-based GDP growth revised up for this year and next Some thoughts Page 2 on Ireland s recovery path Page 3 The economy got off to a strong start in 2014, with GDP - as well as GNP recording solid growth and employment gaining further ground. On the back of a sharp rebound in exports, a pick-up in investment and slight uptick in consumer spending, GDP increased by 4.1% year-on-year in the first quarter (and was up 2.7% on a quarterly, seasonally adjusted basis). This broadening out of activity and spill-over to the labour market is in keeping with the recovery path for a small open economy such as Ireland s. Prospects for the second quarter also look bright, with high-frequency indicators from new export orders to industrial production and retail sales auguring well for activity. More generally, improving external demand, favourable exchange rate movements and the waning impact of the patent cliff are expected to underpin export growth this year and next, with domestic activity and the continuing recovery in the property market providing additional support to investment. Consumer spending is also set to firm, as household incomes benefit from employment gains and modest earnings growth, and confidence starts to feed through (though ongoing balance sheet repair will have a somewhat dampening effect). Taking the first quarter data and more recent information into account, we have revised upwards our forecasts for GDP growth in 2014 and 2015, to 2.8% and 3.4% respectively. The corresponding GNP figures are 2.2% and 2.9%. As overall growth strengthens, the unemployment rate is set to fall this year and next. Inflation is expected to remain relatively subdued though, given the spare capacity in the economy. Outlook Economic Activity Page 4 Activity strengthening The Labour Market Page 5 Labour market steadily improving Housing Market Page 8 Housing market recovering Inflation Page 9 Subdued inflation continuing Public Finances Page 10 Public finances on track Contact Us Page 11 2013 2014 Q1 (Y-o-Y) 2014(f) 2015(f) GDP 0.2% 4.1% 2.8% 3.4% GNP 3.2% 3.4% 2.2% 2.9% Employment Growth 2.4% 2.3% 2.2% 2.0% Employment ( 000 change) 44 43 42 39 Unemployment Rate (average) 13.1% 12.0% 11.5% 10.4% CPI 0.5% 0.1% 0.5% 1.3%
Some thoughts Let me begin this piece with a question, what happens after the fall? Or put another way, what do recoveries following economic and financial crises look like and what does this mean for Ireland? These and similar types of questions have been asked several times over in recent years, and there is now a sizeable body of research on past crisis episodes and the general patterns observed in their wake. A key conclusion of this literature is that recoveries after periods of financial distress are typically slower, and of a tentative and protracted nature. If we set Ireland s experience following the severe downturn of 2008-09 against the above, the two appear closely aligned. Having rebounded sharply in 2011, GDP dipped back in 2012 before increasing (albeit marginally) in 2013. This rather sluggish pace of recovery is not surprising given historical patterns and also the scale of the adjustment taking place across the different sectors of the economy. Nor does it mean that progress has not been made. As is often the case in an Irish context, it is useful to look beneath and beyond the headline measures of activity. Doing so, it is clear that the economy has been on the mend for some time (with activity to strengthen in the period ahead), and that by-and-large it has been following a recovery path typical of a small open economy. As illustrated overleaf, this path starts with the traded sector and a rebound in exports. Having collapsed in 2008-09, exports of goods and services rose by an average of almost 6% per annum in 2010-11, though the patent cliff and weaker external demand meant that momentum softened in the second half of 2012 and into 2013. Even so, the level of exports in the fourth quarter of last year was around 12½% above the precrisis peak, which owes much to the significant price and cost adjustments that have taken place in recent years. Turning to this year, the available hard and soft data has been positive, as is the outlook for export growth, indicating that this first stage of the recovery is on track. The second stage whereby export growth supports a pick-up in investment - is also moving in the expected direction. Machinery and equipment investment (excluding planes) turned positive in 2011 as firms geared up to meet demand from abroad, and also recorded strong growth in 2013 and the first quarter of this year. Similarly, 2013 saw a rebound in building and construction which carried over into this year. With leading indicators of construction activity signalling expansion, business sentiment improving and additional impetus from the external side expected, prospects for investment look good. So stage two of the recovery is on track. The third point on the path sees employment rise on the back of the rebound in exports and investment. This spill-over to the labour market is evident from the fourth quarter of 2012 on, with employment recording its first full year increase in six years in 2013. There were further job gains in the first quarter of this year, and signs that these are starting to broaden out across sectors. High-frequency indicators also bode well and with the outlook favourable, the third stage of the recovery is on track. The final stage an uptick in consumer spending as employment gains feed through hadn t quite materialised at the end of 2013, but did so at the start of this year. Consumer spending rose by a modest 0.2% year-on-year in the first quarter and while ongoing balance sheet repair is likely to weigh on the strength of the rebound, spending is expected to firm during this year and into next. With that, the fourth stage of the recovery can be said to be on track. The broadening out of activity and improvement in the labour market, which we have seen as the economy has worked its way along the above path, is consistent with the narrative of a recovering economy. So although progress has been sluggish in headline terms, the Irish economy is recovering. Moreover, with all four stages exports, investment, employment and consumer spending now on track, GDP growth is set to strengthen and become more balanced in 2014-15. Having started with a question, I ll end with an answer, after the fall comes a recovery, which in Ireland s case is set to accelerate this year and next. Loretta O Sullivan Chief Economist 2 Bank of Ireland
on Ireland s recovery path 3 Bank of Ireland
Economic Activity Activity Strengthening Small increase in GDP in 2013 Solid start to 2014, led by a rebound in exports GDP is now estimated to have risen by 0.2% in 2013, rather than declining by 0.3% as previously reported. The patent cliff in the pharmaceutical sector weighed on goods exports and GDP again last year, although lower profit outflows from the sector boosted GNP, which rose by 3.2% (revised down slightly from 3.4%). While growth in total exports slowed to 1.1%, it outpaced a 0.6% increase in imports, meaning net exports made a positive contribution to GDP. Last year also saw a further contraction in domestic demand, though the pace of decline slowed to just 0.3%. Methodological changes to the way national accounts are compiled across the EU led to a rise in the level of Ireland s nominal GDP in 2013 (and prior years), by some 10 billion. Having contracted marginally in the final quarter of 2013, GDP rebounded strongly in the first quarter of this year, rising by 2.7% on a quarterly seasonally adjusted basis (GNP was up 0.5%). The annual rate of GDP growth accelerated to 4.1%, with both net exports and domestic demand contributing positively. Exports rose by 7.4% yearon-year, driven by an increase in goods exports (of over 10%), which reflected in part the waning impact of the patent cliff. Services export growth was softer (4.3% year-onyear), following a strong increase in the fourth quarter of 2013, but this is likely to prove temporary as the latest surveys point to healthy export order books. In general, the external environment remains favourable - the recoveries in Ireland s main trading partners are continuing, though forecasts for growth in the US this year have been revised down after adverse weather conditions resulted in the economy contracting in the first quarter. Exchange rate developments should also provide a boost to exports, as the euro weakens against both sterling and the dollar. Overall, a much stronger export performance is expected this year compared to last, though not necessarily at the same pace as in the first quarter (which benefited from positive base effects as goods exports fell very sharply in the first quarter of last year). Export growth of 4.0% is projected for 2014 as a whole, picking up to 4.5% in 2015. Exports and New Orders Core investment rising strongly The small fall in domestic demand in 2013 masked some positive developments. In particular, core investment (excluding spending on planes) rose for a second consecutive year, increasing by 3.4%. Investment in plant and machinery (excluding planes) and building and construction both rose, offsetting a decline in investment in intangible assets which had recorded a strong increase in 2012. Turning to this year, core investment increased at a double digit annual pace in the first quarter and should continue to benefit from improving external and domestic demand, and a solid FDI pipeline. Indeed, there is scope for investment - which as a share of GDP still remains low - to rise in the medium-term. In particular, the rate of new house building, while picking up, is running well below what will be required to meet the likely demand for housing over the coming years. 4 Bank of Ireland
Investment Activity by Sub-component and consumer spending recovering. Consumer spending fell again in 2013, though the pace of decline slowed through the course of the year and the first quarter of this year saw a small annual gain of 0.2%. High-frequency data, including retail sales and VAT receipts, suggest further growth in the second quarter. Some of the factors that have held back spending in recent years, including uncertainty and high unemployment, have started to unwind and consumer confidence has risen as labour market conditions have improved. One indication of the turnaround in sentiment is the strength of new private car sales, which rose by almost 26% year-on-year between January and June and according to the industry performed strongly in July, leaving 2014 on track to be the best year for such sales since 2008. Further employment gains and modest growth in earnings are expected to underpin a rise in household disposable income, and so support a continuing and broader recovery in spending. However, ongoing fiscal consolidation and balance sheet repair will remain a constraint on government spending and private consumption growth. The latter is expected to average 1.2% this year the first full-year increase since 2010 and 1.4% in 2015. Personal Consumption & Retail Sales Outlook is for strengthening and more balanced growth Imports are forecast to rise as exports and domestic demand pick up, which along with developments in cross-border income flows and international transfers, implies a surplus on the current account of the balance of payments this year and next, of around 4.4% of GDP. Methodological changes at EU-level have resulted in downward revisions to the current account, though the trend of recent years remains intact a surplus both in absolute terms and as a share of GDP. Drawing all of these elements together, the outlook is for strengthening and more balanced economic growth in 2014-15, as domestic demand makes a positive contribution for the first time since 2007. Specifically, GDP is forecast to increase by 2.8% in 2014 (revised up from 2.4% in our May Outlook), with growth accelerating to 3.4% in 2015 (up from 3.2%). 5 Bank of Ireland
downside risks and upside potential. As always, there are risks to the outlook. External risks relate, amongst other things, to growth in Ireland s major trading partners and in particular, the slower pace of the economic recovery in the euro area. On the upside, competitiveness may receive a boost from exchange rate movements. Domestically, downside risks include the need for continuing balance sheet repair across the different sectors of the economy. In terms of upside potential, there is the possibility that investment could rise by more than projected, while stronger economic activity and tax take may provide scope for some easing in the scale of the budgetary adjustment planned for 2015. Contributions to Growth Real Activity (% change) 2013 2014(f) 2015 (f) Personal Consumption -0.8 1.2 1.4 Government Consumption 1.4-1.0-0.5 Investment -2.4 11.0 11.0 - Construction 14.1 11.7 13.5 - Machinery and Equipment 1.8 11.0 8.2 Exports 1.1 4.0 4.5 Imports 0.6 3.8 4.2 GDP 0.2 2.8 3.4 GNP 3.2 2.2 2.9 6 Bank of Ireland
Labour Market Labour market steadily improving Solid employment gains set to continue supporting consumer spending Employment rose for a sixth consecutive quarter in the first quarter of 2014, with a net gain of 1,700 jobs taking the annual increase to almost 43,000 (2.3%). The latter was due exclusively to a rise in full-time jobs (the numbers working part-time fell slightly). Services - notably accommodation & food services and professional & scientific activities - accounted for more than half of the increase in employment, though there were also job gains in agriculture and, reflecting the recent pick up in building activity, in construction. The first quarter also saw an expansion of the labour force, as rising participation offset the impact of net outward migration. The unemployment rate remained on its downward trend, falling to 12% from 13.7% a year earlier. The continuing fall in the unemployment rate (to 11.6% in June) together with other high-frequency indicators, including the jobs component of the Purchasing Managers surveys, suggests employment rose again in the second quarter. In addition, there has been a steady improvement in hiring intentions amongst businesses during the course of this year, pointing to further job gains ahead. More generally, strengthening economic activity will support employment, which we expect to increase by 2.2% in 2014 and 2.0% in 2015. The labour force is also projected to expand over this period, while the unemployment rate is forecast to average 11.5% this year, falling to an average of 10.4% in 2015. Notwithstanding the improvement in the labour market to date, whole-economy earnings have remained subdued. While average weekly earnings rose marginally in the first quarter, they were still 0.4% lower than in the same period of 2013. This headline figure masks a small pick-up in private sector earnings, which rose by 0.7% year-on-year, while public sector earnings fell by 1.8%. Overall earnings growth is expected to turn positive during 2014, ticking up further next year. Coupled with continuing employment gains this will support household disposable income, which in turn will support the recovery in consumer spending. Employment & Unemployment 7 Bank of Ireland
Housing Market Housing market recovering Activity, prices The pick-up in activity evident in the residential housing market over the course of last year continued into 2014. The number of transactions in the first half of the year was up circa 35% on the same period of 2013, with sales broadly based - outside of Dublin sales increased by nearly 40% and in Dublin by 30%. Residential property prices also continued to trend upwards. Nationally, prices rose by 12.5% in the year to June, driven by substantial gains in Dublin, though property prices outside of the capital also increased on an annual basis, albeit modestly. Positive price growth has generated some supply momentum in the new and second-hand markets. The latest DAFT report notes that some 6,000 Dublin properties were listed for sale in the first half of the year, the largest inflow since the first half of 2008. The stock of properties for sale has not risen however, rather it has continued to fall (to just over 30,000 in the second quarter of 2014, from nearly double that level three years ago). This follows from the increase in activity and also the speed of transactions, with just under 60% of properties listed now selling within four months, up from 45% a year ago. and the mortgage market showing signs of recovery. In the mortgage market, the value and volume of loans rose sharply in the first quarter of this year, each up by well over 60% on an annual basis. However, this was partly down to strong base effects from a particularly weak first quarter in 2013 (which owed much to the closing of the TRS mortgage interest relief scheme at the end of 2012). Cash transactions are still playing a large role in the market, with approximately 50% of residential property transactions in the first quarter of 2014 conducted without a mortgage, similar to the level last year. Looking ahead, improving labour market conditions, consumer confidence and an increase in household incomes should help boost demand for house purchase, supporting property prices and activity in general. These developments are expected to prompt a supply response, both in terms of more second-hand properties coming on to the market and a gradual uptick in house building over the course of this year and into next. The first five months of 2014 saw completions - which fell to a low of 8,300 in 2013 - rise by almost a third on an annual basis, with leading indicators such as housing starts and the construction Purchasing Managers Index also auguring well. Given the starting point however, there remains scope for a significant increase in residential construction in the coming years to meet medium-term demand (which is estimated at circa 25,000 units per annum). Housing Transactions 8 Bank of Ireland
Inflation Subdued inflation continuing Inflation remains low Reflecting weak external and domestic price pressures, annual inflation was subdued in the first half of 2014, averaging just 0.2% on a CPI basis. Declines in energy prices and a fall in mortgage interest due to ECB rate cuts also had a dampening effect, with mortgage interest taking nearly 0.5% points off the annual rate in June. The HICP measure of inflation which is the European standard and excludes mortgage interest - has been similarly subdued, averaging 0.3% in the first half of the year and below the Euro area rate. Inflation excluding mortgage interest and energy products and is likely to rise only gradually. Inflation has crept higher in recent months - CPI inflation picked up to 0.4% in June (from -0.1% in February), while HICP inflation rose to 0.5% (from 0.1%). This trend is expected to continue over the second half of 2014 and in 2015, though the pace of the increase is set to remain modest. Energy prices have stopped falling and, because of base effects, are set to add a little to inflation over the coming months (absent an oil price spike ). The recent fall in the euro/sterling exchange is likely to put some upward pressure on inflation, as is the expected strengthening of domestic demand. At the same time, however, modest earnings growth and spare capacity in the economy will help to keep a lid on price increases. Overall, we expect both CPI and HICP inflation to average 0.5% in 2014, picking up to 1.3% in 2015. Inflation 9 Bank of Ireland
Public Finances Public finances on track Progress on the budgetary front is continuing with the State funded into 2015. The planned adjustment to meet the Excessive Deficit Procedure targets is now largely complete. The Government is targeting a General Government deficit of 4.8% of GDP this year and a downward trajectory for the General Government debt ratio. The latter is likely to have peaked in 2013 at around 123% of GDP. The latest data indicate that the public finances are on track, with the half-year Exchequer figures showing an increase in tax revenues while expenditure control has been kept tight. The Exchequer deficit fell to 4.9 billion in the first half of 2014, from 6.6 billion a year earlier. Total tax revenue increased by 868 million (4.9%) to 18.5 billion in the six months to June, ahead of budget targets. Income tax and VAT performed particularly well, reflecting the ongoing improvement in the labour market and sentiment. Expenditure control remains tight post the EU-IMF Programme, with net voted expenditure down 2.1% on an annual basis in the first half of the year and slightly under the budget target. The spending target is being achieved despite a small overrun in health, which was 200 million ahead of profile, although this was somewhat offset by a 130 million underspend in social welfare, again due to the improving labour market situation. The improvement in the public finances has helped reduce yields on Irish debt, with the 10-year bond trading at a record low yield of around 2.3%, down from about 4% one year ago. Ireland is now fully re-engaged in international debt markets and has already raised 7 billion in funding this year, which represents approximately 87% of the funding target for the year as a whole. With over 25 billion in cash, the State is funded through to the end of 2015. This improved position has supported a sovereign rating upgrade by S&P, who are now rating Ireland at A-. Irish 10-Year Yield 10 Bank of Ireland
Contact Us Economic Research Unit (ERU) To discuss any aspect of this report, contact our Economic Research Unit (ERU): Chief Economist, Bank of Ireland: Dr. Loretta O Sullivan Tel: +353 (0) 766 244 267 Senior Economist: Michael Crowley Tel: +353 (0) 766 244 268 Economist: Patrick Mullane Tel: +353 (0) 766 244 269 e-mail: eru@boigm.com Keep in touch with the markets, visit: www.bankofireland.com/economicresearch Group Communications Media Relations Manager, Anne Mathews Tel: +353 (0) 766 234 771 Disclaimer This document has been prepared by the Economic Research Unit at The Governor and Company of the Bank of Ireland ( BOI ) for information purposes only and BOI is not soliciting any action based upon it. BOI believes the information contained herein to be accurate but does not warrant its accuracy nor accepts or assumes any responsibility or liability for such information other than any responsibility it may owe to any party under the European Communities (Markets in Financial Instruments) Regulations 2007 as may be amended from time to time, and under the Financial Conduct Authority rules (where the client is resident in the UK), for any loss or damage caused by any act or omission taken as a result of the information contained in this document. Any decision made by a party after reading this document shall be on the basis of its own research and not be influenced or based on any view or opinion expressed by BOI either in this document or otherwise. This document does not address all risks and cannot be relied on for any investment contract or decision. A party should obtain independent professional advice before making any investment decision. Expressions of opinion contained in this document reflect current opinion as at 29 th July 2014 and is based on information available to BOI before that date. This document is the property of BOI and its contents may not be reproduced, either in whole or in part, without the express written consent of a suitably authorised member of BOI. The Governor and Company of the Bank of Ireland is regulated by the Central Bank of Ireland. In the UK, The Governor and Company of the Bank of Ireland is authorised by the Central Bank of Ireland and the Prudential Regulation Authority and subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority. Details about the extent of our authorisation and regulation by the Prudential Regulation Authority and regulation by the Financial Conduct Authority are available from us on request. The Governor and Company of the Bank of Ireland is incorporated in Ireland with limited liability. Registered Office - 40 Mespil Road, Dublin 4, Ireland. Registered Number - C-1 Bank of Ireland