Quarterly Bulletin 2021:4 – rebound in the Irish economy expected to be followed by a sustained period of robust growth

• Modified domestic demand is forecast to grow by 5.5 % in 2021, 7.1% in 2022 and 4.1% in 2023

• The stronger outlook for growth sees domestic economic activity return to pre-pandemic levels this year

• The combination of a surge in demand, supply bottlenecks and labour shortages in some sectors is leading to higher inflation in the near term

The Central Bank has today (6 October 2021) published the fourth Quarterly Bulletin of 2021.

On the launch of the Quarterly Bulletin, Mark Cassidy, Director of Economics and Statistics said “As the easing of public health restrictions continues, the rebound in the Irish economy in recent months is expected to be followed by a sustained period of robust growth. Domestic consumption, investment and employment are currently growing at a pace at or above what was expected at the time of the last Bulletin. We now expect domestic economic activity to be back to pre-pandemic levels this year and broadly to where it would have been in the absence of the pandemic by end-2023. At the same time, businesses and households are facing higher costs and prices due to a combination of supply bottlenecks and surging demand, resulting in higher transportation, energy and other input costs. Many of the current drivers of inflation are expected to ease through 2022 and 2023. However, a stronger rebound in household spending, more persistent supply disruptions, or a slower labour supply response could result in higher inflation than currently anticipated. Promoting sustainable growth in Irish living standards requires careful management of domestic economic policy as it moves away from a focus on pandemic-related measures.”

As public health restrictions have been eased through 2021, the Irish economy has continued to recovery strongly, and domestic economic activity is expected to recover its pre-pandemic level by the end of this year. While uncertainty remains high, our forecasts assume that the vaccination programme allows the pandemic to be managed in a way that the public health restrictions are fully removed in line with the Government’s announced schedule and without the need for a re-introduction of significant public health restrictions over the forecast period. This positive momentum and the broadly favourable international backdrop lead to a more positive outlook than at the time of the previous Bulletin in July, with the forecasts for economic growth this year and next revised upwards.

Domestic demand is forecast to grow by 5.5% this year (from 3.4% previously), and by 7.1% next year (from 5.6% previously). In 2023, the growth rate is expected to decelerate slightly as economic conditions normalise, but it is still forecast to be 4.1%. A recovery in consumption will play a substantial role in this, as household spending relative to incomes normalises. Consumption is forecast to grow by 6.2% this year, and by 8.3% in 2022 and 5.1% in 2023.

GDP figures in Q2 2021 highlight the difference between the externally focussed and the domestic economy, with net exports of predominantly foreign-owned multinationals in pharmaceuticals and ICT sectors driving headline growth. Multinational Enterprises (MNEs) are forecast to remain the main driver of export growth, but strengthening world demand is also expected to lift domestic firms’ exports. GDP is projected to grow by 15.3% in 2021 as a whole, 7.2% in 2022 and 5.3% in 2023.

Clear evidence of the improving economy can be seen in the labour market, with strong employment growth leading to a more rapid fall in the unemployment rate over the forecast horizon. We now expect the unemployment rate to average 7.2% in 2022, and to fall further to just under 6% by end-2023. However, the experience of the pandemic and the path ahead varies across sectors. Some sectors will take longer to recover to their pre-COVID levels of employment due to either weaker demand or difficulties in finding suitable workers. At the same time vacancies in many sectors and occupations that have been less negatively affected by the pandemic are rising, and some sectors are seeing relatively strong wage growth. Overall earnings growth of 5.1% is expected this year, before decelerating to 4.8% in 2022 and 3.4% in 2023.

Rising wage costs in sectors where labour shortages are most evident are not currently feeding into a broad-based rise in consumer price inflation. Current inflation relates more to supply bottlenecks combining with a sharp pick-up in demand globally as economies roll-back public health restrictions. This is reflected in higher costs for shipping, energy and certain raw materials. HICP inflation of 2.9% is now expected in 2022, driven by the current high rates of energy inflation continuing into the first half of next year, with consumer price growth moderating to 1.9% in 2023. The current drivers of headline HICP inflation over the near-term lead to the stronger forecast in the current Bulletin, but are expected to ease through 2022 and 2023.

The outlook is still subject to higher than normal levels of uncertainty, but over the forecast horizon risks to the growth outlook are marginally to the upside. A more extensive use of savings accumulated during the pandemic for consumption purposes than assumed in our forecasts would boost domestic demand further in 2022 and 2023. However, in the presence of more persistent supply bottlenecks, real growth could be more constrained and broader price pressures could become more prominent.

Should supply bottlenecks and labour shortages remain over the forecast horizon, the potential for more persistent inflationary pressures would increase, with businesses less able to carry higher input costs without increasing their prices. Similarly, if households begin to expect higher inflation, this could become self-fulfilling as firms and workers bid up prices and wages in anticipation, which could in turn lead to further inflation. This would be amplified if labour supply is slow to adjust and mismatches between jobs in high demand sectors and workers available to fill them continue. Sectors such as construction could be particularly affected, given the expected rise in demand in the years to come, both for the delivery of new housing and in upgrading housing and other infrastructure in-line with climate action targets.

The monetary and fiscal policy response during the pandemic has played an important role in limiting the economic costs. From a domestic perspective, as the necessary pandemic support measures are unwound, it is important that pro-cyclical imbalances are avoided as the focus turns to medium-term challenges. In doing so, necessary infrastructure investment should be carefully managed, and supported by wider policy initiatives, so that the challenges in housing and in climate action can be addressed without unnecessarily adding to inflationary pressures. Ensuring sustainability of the public finances by achieving a lower debt ratio over the medium-term will help to avoid excessive inflationary pressures domestically, while building long-term resilience and ability to respond to future shocks.