Material risk of overheating if strong economic expansion continues - Central Bank of Ireland Quarterly Bulletin

• Upward revision of growth forecast for Irish economy - economic growth now expected to be 4.9 per cent in 2019 and 4.1 per cent in 2020
• In the event of a no-deal Brexit, growth will be significantly weaker in 2020, with unemployment higher than it would be if a deal is agreed
• If a no-deal Brexit is avoided, there is a material risk that continued strong expansion could give rise to overheating in the economy

The Central Bank of Ireland has today published its third Quarterly Bulletin of 2019. The Bulletin examines recent trends in the domestic economy and provides the Central Bank’s forecasts for the Irish economy and its views on domestic economic policy issues.

The Bulletin reports:

• Economic growth expected to be 4.9 per cent this year, moderating to 4.1per cent in 2020.
• The unemployment rate is projected to decline from 4.7% in 2019 to 4.5% in 2020.
• Compensation per employee is forecast to increase by 3.6% in 2019 and 4.1% in 2020.
• Inflation is projected to pick up moderately. Current assumptions point to a forecast of 1.0 per cent and 1.2 per cent for HICP inflation in 2019 and 2020.
• In the event of a no deal Brexit from end-October 2019, our estimates suggest that economic growth would be reduced to 0.7 per cent next year, with around 34,000 fewer jobs by the end of 2020 compared to the central forecast.

The Central Bank’s central forecast is that growth in 2019 and 2020 is expected to come primarily from the continued expansion in underlying domestic demand, reflected in solid growth in consumer spending and underlying investment. The central forecasts are based on a deal on Brexit being reached and a transition period coming into effect until end 2020. Given the unprecedented nature of Brexit, and the uncertainties in the international trading environment, there is considerable uncertainty around potential outcomes.

On the domestic side, the recent strength of growth in output and employment have further elevated the cyclical position of the economy, eroding already limited domestic spare capacity. In the event that a disorderly, no deal Brexit can be avoided, underlying economic activity is expected to perform strongly in 2019 and 2020. Given the already cyclically advanced stage of the economy, there is a material risk that continued strong expansion could give rise to overheating and generate sustained upward wage pressures.

Director of Economics and Statistics, Mark Cassidy, said:

“In the event that the disruption from a no-deal Brexit is avoided, there is a risk of overheating occurring in the Irish economy given that output is now at or close to full capacity.

“In the event that a no-deal Brexit were to occur there would be a significant weakening of activity across many parts of the economy. Our current projection is that in the event of a no-deal Brexit, the economy would expand by 0.7 per cent in 2020, as opposed to 4.1 per cent if a deal can be agreed.  And our forecast is for around 34,000 fewer jobs by end 2020 and over 100,000 fewer jobs over the medium term compared to our forecast if a deal on Brexit can be reached.

“The uncertainties around Brexit and managing the risk of overheating increase both the challenge and importance of charting the appropriate fiscal policy path. If a disorderly Brexit can be avoided, the underlying outlook and, in particular, the risk of overheating, emphasises the importance of a more ambitious improvement in the fiscal position. With output at or close to potential, a tighter fiscal policy would help to manage demand pressures and reduce the risk of overheating and a return to boom-bust type conditions.

“On the other hand, if a disorderly Brexit were to occur, there would be a material deterioration in the public finances and the fiscal environment would be significantly more challenging. In this case, there may be the need to provide targeted support to the parts of the economy that are most affected. However, it is important that any fiscal response is consistent with long-run debt sustainability and does not undo the hard work in re-establishing Ireland’s fiscal credibility and risk the emergence of unsustainable debt dynamics.”

See also:

• Central Bank Explainer: What does overheating in the economy mean?