Economic activity gathers pace

Produced by the Economic Research Unit October 2014 A quarterly analysis of trends in the Irish economy Economic activity gathers pace Positive data flow Recovery broadening out GDP growth revised up to 5% for 2014 News on the economic front has been positive through 2014, with headline measures of activity for the first and second quarters, and high-frequency data for the third, confirming that the economy is strengthening. The data also show that the recovery has broadened out, with domestic demand now contributing to growth along with exports. This was expected and is in line with the recovery path that Ireland has been following for some time. The magnitude of the improvement has surprised on the upside though. GDP increased by 3.8% year-on-year in the first quarter, with the rate of growth picking up to 7.7% in the second. While the latter likely overstates the underlying strength of the economy, it points to strong momentum and a recovery that is gaining ground. Taking the first half outturn data and more recent information into account, we have revised up our forecast for GDP growth this year to 5% (from 2.8% in our July Outlook). For 2015, growth of 4.2% is projected. This is up from 3.4% previously and reflects in part the changed fiscal stance - Budget 2015 provided for a 1bn stimulus rather than the originally envisaged consolidation of 2bn. Exports next year are expected to benefit from relatively strong growth in the US and UK, and from the recent decline in the euro, though the weakness of the euro area economy is a concern. Investment is forecast to increase at a double-digit pace as demand picks up further, while ongoing employment gains, modest earnings growth and the measures announced in the Budget should support household disposable incomes and stronger consumer spending (albeit balance sheet repair is still continuing and will remain a headwind). Ireland s Recovery Path Page 2 Economic Activity Page 3 GDP growth revised up Labour Market Page 6 Continuing employment gains Housing Market Page 7 Housing activity strengthens Inflation Page 8 Inflation still subdued Public Finances Page 9 Budget 2015 published With overall activity increasing, unemployment is forecast to fall to 10% in 2015, from just over 11% this year. Inflation in both years is expected to remain relatively low however, given the spare capacity in the economy. Contact Us Page 10 Outlook 2013 2014 Q2 (Y-o-Y) 2014(f) 2015(f) GDP 0.2% 7.7% 5.0% 4.2% GNP 3.3% 9.0% 4.2% 3.8% Employment Growth 2.4% 1.7% 2.0% 2.3% Employment ( 000 change) 44 32 37 44 Unemployment Rate (average) 13.1% 11.5% 11.3% 10.0% CPI 0.5% 0.3% 0.5% 1.3%

Ireland s Recovery Path 2 Bank of Ireland

Economic Activity GDP growth revised up Activity has strengthened on the back of a strong export performance The second quarter of 2014 saw a second consecutive quarterly increase in GDP (1.5% on a seasonally adjusted basis), and a sharp acceleration in the annual pace of growth to 7.7% (from 3.8% in the first quarter). Export growth also accelerated over the first half of the year. Goods exports were some 13% higher year-on-year, though this strong performance was partly attributable to positive base effects (the expiry of certain patents resulted in a fall in output and exports from the pharmaceutical sector in early 2013), as well as methodological changes to the way the national accounts are compiled (goods which are owned by Irish resident firms but are manufactured and shipped from abroad are now recorded as Irish exports). At 7%, the annual increase in services exports was solid but more moderate, and in line with the rate of growth recorded for 2013 as a whole. Looking ahead, healthy order books for both manufacturing and services, trading partner growth, some further easing of the patent cliff effect, and the favourable exchange rate movements of late, are expected to support the traded sector. Reflecting the strong first half outturn and these more recent trends, export growth of 7.5% is now forecast for this year and 5.5% for next year. Exports & New Orders 14.0 % PMI Index 70 12.0 % 10.0 % 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2012 2013 2014 2014 2015 60 50 40 30 20 Exports (LHS) M anuf acturing PM I - New Export Orders (RHS) Services PM I - New Export Orders (RHS) a pick-up in investment On the domestic front, annual investment growth averaged close to 12% in the first half of 2014, with broad based gains across the different sub-components. Spending on intangible assets (mainly research and development) - which had fallen sharply in 2013 picked up, as did new house completions. House building will receive a boost next year from the increase in social housing units announced as part of Budget 2015, while the extension of the home renovation incentive to rental properties and ongoing FDI flows are expected to provide further support to construction activity. On the machinery and equipment side, spending (excluding on aircraft) has been increasing on an annual basis since the first quarter of 2013, and should continue to do so as firms respond to strengthening demand at home and abroad. Total investment growth in the region of 12% is projected for 2014 and 2015, bringing the share of investment in GDP to almost 18% next year. As this is still below the long run average, there is scope for investment to rise over the medium-term. 3 Bank of Ireland

Investment Activity by Sub-component 10 0 % 80% 60% 40% 20% 0% -20% -40% -60% Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2012 2013 2 0 14 2 0 14 2 0 15 Building & Construction Machinery & Equipment Machinery & Equipment (ex planes) Intangibles and improving consumer spending. The first half of the year also saw a rise in consumer spending, with the annual gain of 1.8% recorded in the second quarter the strongest in four years. High-frequency data, including retail sales and VAT receipts, suggest further growth in the third quarter. Rising employment and confidence are supporting consumer spending, which is forecast to expand by 1.4% this year - the first full-year increase since 2010. Growth of 2% is expected next year, as household disposable incomes benefit from additional job gains, a pick-up in earnings and the measures announced in the Budget. However, continuing balance sheet repair is likely to remain a headwind for some time to come. Meanwhile, government consumption growth is forecast to moderate to 1.5% in 2015, from an estimated 2% this year. Personal Consumption & Retail Sales 10.0 % 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2012 2 0 13 2 0 14 2 0 14 2 0 15 Consumption Retail Sales Strong and balanced growth ahead Overall, the outlook is for solid economic growth. Taking into account the first half outturns - especially on the exports side - and the latest information, GDP growth of 5% is forecast for this year (up from 2.8%). For 2015, growth of 4.2% is projected (3.4% previously). With domestic demand expected to turn positive this year and increase again next year, growth is also set to become more balanced. Net exports will still make a positive contribution though, even with imports rising. Given this, the trade surplus is projected to increase further, which along with developments in crossborder income flows and international transfers, implies a surplus on the current account of the balance of payments of 5% in 2014, and 5.3% in 2015. 4 Bank of Ireland

with risks in both directions. There are, as always, risks to the outlook. At the current juncture, downside risks relating to the weakness of the euro area economy and increased market volatility (on foot of concerns about global growth generally and geo-political and other worries) are especially prevalent. On the upside, given the strong data for the first half of the year, there may be more momentum in the economy than built into our forecasts, while investment could rise by more than projected given its still low share in GDP. Contributions to Growth 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% -8.0% -10.0% 2008 2009 2010 2011 2012 2013 2014 2015 Domestic Demand Net Exports GDP Real Activity (% change) 2013 2014(f) 2015 (f) Personal Consumption -0.8 1.4 2.0 Government Consumption 1.4 2.0 1.5 Investment -2.4 12.0 12.0 - Construction 14.1 13.2 15.9 - Machinery and Equipment 1.8 12.5 8.3 Exports 1.1 7.5 5.5 Imports 0.6 6.3 5.1 GDP 0.2 5.0 4.2 GNP 3.3 4.2 3.8 5 Bank of Ireland

Labour Market Continuing employment gains Employment rises further Employment rose in the second quarter of 2014, though the annual rate of growth slowed to 1.7% (31,700), from 2.3% in the first quarter. The increase in the numbers at work was more than accounted for by a rise in full-time employment, and was again broad based. The largest gains were across the services sector, including accommodation and food services, professional, scientific and technical activities, and administrative and support services. Employment in construction also increased, reflecting the pick-up in building activity, but fell in industry and slowed notably in agriculture. The participation rate eased in the second quarter too, leading to an unexpected decline in the labour force, while the (seasonally adjusted) unemployment rate stood at 11.5%. This was down from 12% in the first quarter and from 13.6% a year earlier. while unemployment is on a downward trajectory. The unemployment rate has fallen further since (to an estimated 11.1% in September) which, along with other high-frequency indicators including the jobs components of the Purchasing Managers surveys and income tax/prsi receipts, points to additional job gains over the second half of the year. For 2014 as a whole, employment growth of 2% is forecast. This is down slightly from our July projection, despite the upward revision to GDP growth (as this owes much to the strong performance of the relatively low labour-intensive pharmaceutical sector), and takes account of the first half labour market outturn. Looking forward to 2015, employment growth is expected to accelerate to 2.3%, supporting a decline in the average unemployment rate to 10% from a projected 11.3% this year. Employment & Unemployment % of Labour Force 3.5% 2.5% 15.0 % 1.5% 14.0 % 0.5% 13.0 % -0.5% -1.5% 12.0 % -2.5% 11.0 % -3.5% -4.5% 10.0 % -5.5% Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2012 2013 2014 2014 2015 9.0% Employment Growth (LHS) Unemployment Rate (RHS) 6 Bank of Ireland

Housing Market Housing activity strengthens Activity, prices Activity in the residential property market has picked-up in the course of 2014. The number of transactions in the first nine months of the year is up circa 37% on the corresponding period of last year, with prices rising as well. The annual rate of price growth nationally accelerated to 15% in September, from 6.4% at the end of last year. The recovery in prices has also broadened out across the country (prices outside of Dublin rose by 7% on an annual basis in September), although Dublin continues to lead the way by some distance. The increase in price has generated some momentum in new house building - the number of completions in the twelve months to August totalled almost 9,990, compared to the 8,300 units built in 2013. However, the total stock of properties for sale has fallen to its lowest level since March 2007 according to the latest DAFT report, in spite of a rise in the number of properties listed for sale. The latter is being more than offset by the speed at which properties are being sold, with almost 60% of those listed for sale now selling within four months (compared to 39% two years ago). and mortgage lending are picking up In the mortgage market, the volume and value of loans for house purchase rose in the second quarter of the year, increasing by 52% and 60% year-on-year respectively. First-time buyers remain the dominant purchaser category, accounting for slightly more than half of mortgage draw downs (in numbers). On the approvals front, data available to August point to a rise in mortgage lending in the third quarter. As the volume of mortgages being drawn down is well below the number of housing transactions, cash buyers are still playing a large role in the market, though the share of transactions accounted for by this group has fallen slightly (to below 52% in the second quarter, from almost 56% in the final quarter of 2013). as the housing market recovers. Looking ahead, improving confidence, labour market conditions and household incomes are among the factors supporting housing demand. At the same time, leading indicators of activity including the construction PMI and housing starts point to a further increase in new house building. This may help to moderate the increase in house prices, though it will take some time for the rate of house-building to reach the level needed to meet the likely demand for housing over the medium-term. The Central Bank has also proposed the introduction of new macro-prudential measures that could have a bearing on housing market activity. 7 Bank of Ireland

Inflation Inflation still subdued Inflation weak Annual inflation has been subdued in 2014 to date, averaging 0.3% in the first nine months of the year. External price pressures have been weak, reflecting the weak inflationary environment globally. Energy price reductions and ECB interest rate cuts have also had a dampening effect, with mortgage interest taking about 0.5 percentage points off the annual rate of inflation in September, and energy price reductions around 0.3 percentage points. Similarly, domestic price pressures (including wage pressures) have been muted. The HICP measure of inflation which is the European standard and excludes mortgage interest - has also been subdued; averaging 0.4% in 2014 to date and just below the Euro area rate of 0.5%. but expected to gradually rise. Inflation may tick up in the coming months and into 2015. Domestic demand is growing once again which should add a little to inflationary pressures, while a number of the measures outlined in Budget 2015 are also likely to have a modest impact. For example, the increase in excise duties on cigarettes will add around 0.1 percentage point to the annual inflation rate in a full year. The recent depreciation of the euro may generate some further upward pressure, as it will make imported goods and services more expensive. On the other hand, the still elevated level of unemployment is expected to limit wage pressures even as the domestic economy picks up, while wholesale energy prices have dropped recently on concerns that demand will fall if global economic growth slows. Overall, we expect both CPI and HICP inflation to average 0.5% this year, increasing to 1.3% next year. Inflation 3.0% 2.5% 2.0% 1.5% 1.0 % 0.5% 0.0% -0.5% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep 2012 2013 2014 2014 2015 CPI HICP 8 Bank of Ireland

Public Finances Budget 2015 published A 1bn stimulus package with the deficit under 3% next year and 10 year yields under 2% Stronger than forecast growth and tax revenues, falling unemployment and lower interest costs allowed the Government to provide a 1bn (c0.5% of GDP) stimulus to the economy in Budget 2015, as opposed to the originally envisaged consolidation of 2bn. The package of measures comprises tax reductions of 420m and an increase in government spending of 630m. The former includes a cut in the top tax rate and an increase in the standard rate tax band, and the latter an increase in current and capital spending. Almost half of the planned increase in current spending is in the area of social protection, which together with the income tax changes will provide a modest boost to incomes and spending next year. The capital expenditure measures include an increased allocation to social housing investment, supporting output and employment in the construction sector. The Department of Finance is projecting a general government deficit of 2.7% of GDP for 2014. This is down from an estimated 3.7% this year and below the 2.9% target. Excluding debt interest costs, a small budget surplus (0.3% of GDP) is expected, the first since 2007. The gross debt to GDP ratio, meanwhile, is forecast to fall to 108.5% in 2015, from a projected 110.5% this year and a peak of 123.3% in 2013. This on-going improvement in the public finances has helped to lower the Government s borrowing costs, with 10-year bond yields now below 2%, compared with 3.5% at the end of 2013. It has also contributed to a sovereign rating upgrade from the three main rating agencies this year. The Government intends to take advantage of the fall in borrowing costs to make an early repayment of some of the IMF loans, which will probably be financed by a combination of running down cash balances and new debt issuance. Government Deficit & Debt % of GDP 0.0% % of GDP 14 0 % -5.0% 12 0 % -10.0% 10 0 % -15.0% 80% -20.0% 60% -25.0% 40% -30.0% 20% -35.0% 2008 2009 2010 2011 2012 2013 2014 2015 0% General Government Deficit (LHS) General Government Debt (RHS) : Department of Finance 9 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 23 rd October 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