How real is Ireland's recovery?

While Ireland’s short-term economic prospects remain positive, the country is not immune to global headwinds and must tackle its debt pile and ongoing housing shortage, writes David McNamara.

2015 looks like something of a turning point for the Irish economy – provisional data show that Gross Domestic Product (GDP) grew by a staggering 7% in the first nine months of last year. Looking ahead to 2016, Irish GDP should continue to grow close to 4%, the fastest pace of growth in Europe. Irish GDP is now 7.3% above its pre-recession peak in 2007, in line with the UK. However, the recovery has been led by the multinational sector. Exports are now 41% above their last peak in 2007, while consumer spending is still 2.5% below peak and employment 8.7% from peak.

Some have been concerned that these staggering rates of growth reflect an overheating in the economy similar to the tail-end of the Celtic Tiger, but an unemployment rate of 8.8% and weak inflation suggest otherwise. In fact, a timely confluence of positive factors combined to supercharge GDP growth last year. Ireland has benefitted from a weaker euro, which boosted exports and tourism; low oil prices, which increased disposable incomes; and quantitative easing from the European Central Bank, which raised asset prices and lowered borrowing costs.

Of course, these tailwinds won’t last forever. Oil prices could quickly spike and the euro has regained ground against the dollar and sterling since the trough in April 2015, but the recovery is also built on more solid foundations. The fall in unemployment from a peak of 15% in 2012 to the current 8.8% has meant more spending by households, thereby boosting the domestic economy.

Indeed, the consumer spending numbers probably provide a truer reflection of where the economy is currently. In Q3 2015, consumer spending was up 3.6% on the year which is in line with the gains in the labour market. Wage growth is now starting to emerge and businesses are feeling sufficiently confident about the future to begin investing again, neatly illustrated in the 41% gain in new commercial vehicle sales last year. Crucially, both households and businesses are continuing to pay down legacy debt, building up resilience to future downturns.

Some emigrants may now be thinking about making the move home. They can expect a strong recovery in the short-term at least but may struggle to find suitable housing in Ireland’s cities. As a consequence of deep cuts in housebuilding during the downturn, Ireland now faces an acute shortage of housing. This has been reflected in soaring house prices and, more recently, in higher rental prices as stricter mortgage lending rules have constrained potential first-time buyers to an ever-crowded rental market. Nonetheless, house prices in many regions still remain relatively cheap compared to incomes, and emigrants with savings built up will find it much easier to get on the

property ladder.

Ireland’s housing shortage has been costly, but it does provide opportunities. A pick-up in the construction sector could provide a third leg to the recovery after exports and consumer spending recoveries – providing employment opportunities for the still sizeable cohort of former construction workers both at home and abroad. It will also ease pressure on property prices. The construction recovery has already begun in Dublin with significant investment in new office space to meet ever-growing demand in the multinational sector, but new housing has been slow to come to market as yet.

Although all looks rosy for the Irish economy in the short-term, it is not immune to global headwinds. Much has been made of recent financial market turbulence, led by slowing growth in China. Ireland’s exposure to China is minimal, but a sharp decline in Asia could impact on confidence in Europe and the US, Ireland’s biggest trading partners. A disruptive exit from the EU by the UK (Brexit) also has the potential to derail our recovery given the importance of our neighbour for trade and investment.

With these risks in mind, Ireland’s government must continue to pursue prudent fiscal policy. The government deficit will be all but closed in 2016, but the debt pile remains sizeable at nearly 100% of GDP. Promises of tax and spending giveaways by the various parties jockeying for position in the general election are therefore disingenuous.

Indeed, new EU fiscal rules provide very limited space for the next government to loosen fiscal policy. This means that tax cuts and spending increases should be targeted to provide the best return for our money. Given that Ireland is a small, open economy with much of the policy levers such as interest rate setting beyond its control, it must continue to run its affairs in a prudent manner to maintain the hard-earned recovery.

David McNamara is an economist with Davy.