Central Bank of Ireland Quarterly Bulletin Q3 2015 

29 July 2015

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The Central Bank of Ireland has today published Quarterly Bulletin Q3 2015.

Comment

Following GDP growth of 4.8 per cent last year, the strong recovery of the Irish economy has continued in the first half of 2015. While the initial strengthening of activity in 2014 was driven by net export growth, the recovery over the past year has become more balanced, with domestic drivers increasingly playing a more prominent role. Although the absence of National Accounts data for the first quarter of 2015 reduces the detail and quality of information available on the performance of the economy in early 2015, the signs emerging from a broad range of other data and indicators point to an increase in the pace of domestic demand growth in the first-half of this year.

While the rebound in domestic demand was initially driven by investment spending, consumer spending is now playing a more prominent role. Moreover, the recovery in consumption, while still modest, appears to be gradually strengthening. Consumption has benefitted from continuing solid growth in employment, particularly full-time employment, which is helping to boost incomes. The ongoing strength of the labour market in 2015, as evidenced by both labour market and tax data, supports the view that the economy has continued to expand solidly in the first-half of this year and corroborates the signal from high frequency retail sales data that the recovery in consumption is gradually strengthening.

On the external side, the high rates of growth in exports and imports in the monthly trade data suggest that some of the impact of contract manufacturing may have carried over into the early part of 2015. Our working assumption continues to be that this represents a step increase in the level of exports and imports and not a lasting upward shift in their growth rates. Looking ahead it is assumed that exports will return to growing broadly in line with projected growth in external demand. Helped by Ireland’s trade links with the US and UK markets and the improvement in the outlook for the euro area economy, this should continue to generate a strong rate of growth for exports this year and next.

On the domestic side, the momentum of recovery has strengthened and the outlook is now more favourable than at the time of our last published forecasts. Further increases in employment, rising real disposable incomes and gradually strengthening consumer confidence are projected to support a pick-up in the growth of consumer spending over the remainder of 2015 and 2016. However, despite recent declines, the high level of household indebtedness remains a headwind to any strong recovery in consumption. In addition, growth in investment spending, abstracting from the volatile aircraft component, is forecast to strengthen further, helping investment, including construction investment, to continue to rebound following a prolonged period of weakness.

These developments suggest a stronger outlook for growth in 2015 and 2016, as compared to the forecasts in the previous Bulletin. Reflecting a more favourable outlook for consumer and investment spending, GDP growth of 4.1 per cent is now forecast for 2015, an upward revision of 0.3 per cent relative to the previous projection. In 2016, again supported mainly by a further strengthening of domestic demand, GDP is forecast to grow by 4.2 per cent, which is 0.5 per cent higher than the previous Bulletin forecast. We would caveat these forecast  by noting that the inclusion of aircraft owned by Irish resident leasing companies in both investment and imports in the National Accounts places significant upside risk to our forecasts for both these components.

Consequently, there may be upside risk tothe projected outlook for domestic demand, though this may be broadly offset by downside risk to the projection for net exports, leaving overall risks to the forecast broadly balanced.

Turning to policy issues, the challenge remains to ensure that the strengthening economic recovery which is underway transitions into a sustainable return to steady growth. While much progress has been made, high public and private indebtedness persists. In some key areas, policy needs to focus on reducing remaining vulnerabilities and strengthening resilience in order to minimise future risks to economic, fiscal and financial stability.

With respect to the public finances, reflecting the stronger economic performance, Exchequer data have been favourable. Tax revenues have grown ahead of target and expenditure has been lower than profile in the first half of the year. Against this background, the General Government Deficit is likely to come in below target in 2015 and Ireland is on course to come out of the Excessive Deficit Procedure by the end-year deadline.

Looking ahead, the strong growth outlook implies that there is no need for fiscal policy to support economic activity and, importantly, also provides an opportunity to move ahead with fiscal consolidation and debt reduction in favourable circumstances. Indeed, with strong growth in prospect, it is important that the fiscal stance does not exacerbate cyclical pressures. Ireland’s past experience demonstrates the damage that can be caused by pro-cyclicality in policy and of the importance of resisting the temptation to consume unanticipated surplus revenues. Given the continuing high level and burden of public debt, it would be best to use such revenues to accelerate debt reduction, leaving the public finances better positioned to address future challenges.

In the banking sector, favourable financial market conditions and the improving economic environment have helped banks reduce their funding costs, which together with reduced impairment charges, has led to a return to profitability. Encouragingly, the stock of nonperforming loans continues to fall. Still, the overall level of NPLs remains high and longterm mortgage arrears of greater than 720 days are still growing, although the pace of increase has reduced significantly. It is notable that, for those banks subject to the mortgage arrears resolution targets (MART), there has been a small decline in the number of accounts in this arrears segment. In terms of the operation of MART, the Central Bank recently announced a shift from common quarterly solution targets across all banks to a bank-specific approach with more granular monitoring of specific cohorts of distressed borrowers where progress has been slower. While challenging, progress is being made and, gradually, the balance sheets of banks and their borrowers are being repaired.