The Central Bank has today (19 September 2023) published its third Quarterly Bulletin of 2023. On the launch of the Quarterly Bulletin, Robert Kelly Director of Economics and Statistics said: “Growth rates in the domestic economy, which were always going to ease from their post-pandemic surge, are expected to slow further as capacity constraints have become more binding. Tighter monetary policy, is gradually beginning to weigh on demand conditions both in Ireland and abroad. Inflation is easing, although it remains high, with its future path being sensitive to further global shocks that might materialise and the persistence of buoyant domestic demand.”
The most significant change since the last bulletin are revisions to National Accounts data for recent years by the CSO. These revisions mean that the domestic economy, as measured by Modified Domestic Demand (MDD), was some 3 per cent larger than previously thought last year. In and of itself this is a positive development, but when placed in the context of already obvious capacity constraints, it highlights the strength of underlying demand relative to supply conditions putting upward pressure on inflation.
The result of this is slower growth in MDD over the forecast horizon in this Bulletin, and marginally more upside risk to the inflation outlook. Economic growth is expected to moderate and MDD is forecast to grow by 2.9 per cent this year, and by 2.6 per cent in 2024 and 2.3 per cent in 2025.
Headline HICP inflation continues to decline from its peak in mid-2022 but the path back to lower rates of inflation is likely to be gradual and uneven. The contribution of external factors to headline inflation in Ireland has declined with domestic factors playing an increasingly important role in influencing inflation dynamics in 2023 and over the forecast horizon. Inflation is forecast to moderate to 3.2 and 2.3 per cent in 2024 and 2025, respectively, as energy, food and industrial goods price growth slows, offsetting more persistent upward pressure on inflation from services. Reflecting the stronger role of domestic factors in driving services inflation in particular, core inflation (excluding energy and food) is expected to be more persistent, and average 2.7 per cent in 2025
Employment growth is forecast to slow in the coming years as capacity constraints in the labour market and broader economy limit the scope for expansion in the labour force. The economy has reached full employment, enabled by inward migration, and measures of labour market slack are low. The pace of jobs growth is forecast to slow in the coming years as capacity constraints, including housing supply, bind further.. With the unemployment rate projected to remain close to 4 per cent out to 2025, tight labour market conditions will place upward pressure on wages, allowing for a catch up in real incomes following the decline in 2022.
Downside risks to the growth outlook are more pronounced than at the time of the last Bulletin. Developments since June are consistent with more pronounced downside risks to growth and upside risk to inflation from weaker and more fragmented international trade. A more expansionary fiscal stance than already announced for 2024 adds to the risk of higher inflation. The central forecasts are also contingent on energy prices continuing on their downward trajectory and monetary policy transmission proceeding in line with expectations.
A key channel of monetary policy transmission is the pass-through from policy rates to retail interest rates on loans and deposits for households and businesses offered by the banking system. Evidence suggests that pass-through in Ireland to new mortgage lending rates and household deposit rates has been weaker so far relative to the rest of the euro area.
As easing of domestic inflationary pressures will depend on the relative balance between domestic demand and supply conditions, it remains important that domestic policy does not work at cross-purposes to what monetary policy is trying to achieve. Consequently, in the near-term it will be important to ensure that the overall stance of fiscal policy is appropriate to contain demand, while enabling greater supply capacity to occur in the economy. The Government’s Summer Economic Statement (SES), and the potential for additional stimulus over and above the SES parameters on Budget day, indicates a procyclical shift in the fiscal stance relative to previous plans. This would amplify demand in an economy already operating at capacity, and risks leading to inflation being higher in Ireland for longer than would otherwise be the case.
In a Signed Article accompanying this Bulletin, Boyd, Keenan and McIndoe-Calder (2023) examine the determinants of earnings growth and the potential reasons for the unexpectedly low growth in wage rates seen during the recent period of high inflation. The analysis points to some possible structural changes occurring in the labour force and the role of fiscal support to households through the cost-of-living measures in containing wage demands to date. However, the full effect of higher inflation, and its impact on inflation expectations, is yet to be fully reflected in wage rate developments. This, combined with the only gradual re-balancing of labour supply and demand over the forecast horizon, underpins the extent of wage growth and the restoration of real wage levels to pre-pandemic levels foreseen in this Bulletin.