Yes, we’ve turned a corner but tough road lies ahead
Beyond the glimmers of hope that occasionally emanated from the headline data, it was clear that there was a consistent narrative – the domestic economy was stuck in reverse while the export-oriented multinational sector performed resiliently, a function of the composition of much of Ireland’s exports – IT, pharmaceuticals and food.
This narrative began to shift during 2013. After years of decline, there were sustained signs that the domestic economy was beginning to stabilise. The economy was adding jobs, consumer confidence was on the rise and retail sales began to perform strongly.
The Troika programme exit raised hopes that the series of tough budgets designed to restore the public finances to good order would soon be drawing to a close. Just as things were looking up domestically, the multinational sector suffered a setback as pharmaceutical exports fell over the so-called patent cliff, pushing the annual rate of growth in exports to a four-year low. In the event, GDP increased by 0.2pc last year, while GNP (which better reflects domestic conditions) expanded by 3.2pc.
More recently, we have seen ample evidence to suggest that the Irish economy has been building on the progress it made during 2013. This has chiefly come from the domestic side of the economy, although net exports remain an important part of the overall growth story.
The broad nature of the recovery is reflected in the three Irish PMI surveys (services, manufacturing and construction). In September 2013, for the first time in six years, all three of them stood simultaneously above the 50 no-change line separating growth from contraction. They have all stayed in positive territory since then. Labour market, retail sales and Exchequer returns data all reflect the positive momentum behind the domestic economy.
Since troughing in early 2012, the total number of people at work in Ireland has steadily improved. The unemployment rate has declined from a peak of 15.1pc to 11.5pc in July of this year, while surveys suggest that this momentum should continue into 2015 at least. Of course, statistics such as these tell only part of the story.
While we draw comfort from the rising numbers at work, we are very concerned about the worrisome issue of long-term unemployment – nearly half of the people on the Live Register in July had been on it for more than one year. Another issue is the lack of opportunities for so many of our young people – we note that the ratio of over-25s to under-25s on the Live Register has surged to 5.8:1 from 5.1:1 at the end of 2012, a move that is likely to have been heavily driven by emigration.
Retail sales have posted eight successive months of annual gains in both value and volume terms. There has been a particularly strong recovery in sales of so-called big ticket items, with the number of new cars licensed in Ireland rising 30pc year-on-year in the first seven months of 2014, while furniture sales are also enjoying a strong bounce, presumably on the back of the brighter signs coming from the housing market.
In what will be a further lift to the retail sector, we expect that earnings growth will turn positive in the near term as there are emerging signs of upward pressure on wages, particularly in the private sector, following years of pay restraint.
The positive momentum in consumer spending is a key factor behind the out-performance of the public finances this year. Exchequer Returns show that year to date tax revenues are up 6.4pc and 2.5pc ahead of guidance, while expenditure is, on the whole, contained. These dynamics are producing a strong tailwind as we head towards October’s Budget.
Favourable currency moves and economic recovery across many of Ireland’s key trading partners provide a helpful backdrop for Ireland’s exporters. The impact of the patent cliff on merchandise exports seems to be easing, with recent industrial production and import data pointing to better prospects for the pharmaceutical sector. Elsewhere, the New Export Orders component of the Investec Services PMI suggests that another good year is in store for exports in that area.
Ireland’s 10 year bond yield represented the market equivalent of a canary in the coal mine as the country gradually slid into the arms of the Troika. It eventually peaked at 13.8pc in July 2011 after Moody’s downgraded the country to ‘junk’. Helped by very significant support from the ECB, but also the market’s recognition of the progress Ireland has made in addressing its challenges, the 10 year yield has now fallen to an all-time low of 1.8pc.
All of the big three ratings agencies – Moody’s, S&P and Fitch – have upgraded Ireland since the start of the year. The NTMA, which has been instrumental in restoring Ireland’s creditworthiness, aims to raise up to €10bn on the bond market next year, a far cry from just three years ago when Ireland was off-limits to investors.
Another sign of the changing times can be found in the banking sector. Recent interim results from the country’s two largest domestic institutions, AIB and Bank of Ireland, confirm that both are profitable and generating capital.
While there have been concerns expressed about the health of banks in other parts of Europe’s periphery, robust stress tests conducted by the Central Bank of Ireland in 2011 and 2013 give comfort around the Irish banking sector as we head towards the ECB’s Comprehensive Assessment later this year.
The flow of funds from the State to the banking sector has been reversed, with the State’s divestments to date in Bank of Ireland having yielded a profit, AIB seemingly being readied for a partial privatisation in 2015 and the IBRC liquidation set to yield an unexpected windfall for the Exchequer.
In all, there is good momentum behind the economy at this time. We expect GDP to grow by 2.5pc this year and by 2.8pc in 2015. However, this does not mean that we can rest on our laurels. Some legacy problems remain from the crisis – aside from unacceptably high unemployment, we still have a significant problem with unsustainable debt in some parts of the economy. These will take time to resolve. Policymakers need to create the conditions so that the next moves forward for the economy will result in wide benefits.
Philip O’Sullivan is Chief Economist with Investec in Ireland.
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