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The Irish Recovery: Stronger and More Broadly Based

The Irish recovery is strengthening: following a stronger-than-expected Q1 performance, we have upgraded our growth forecasts and now expect real GDP growth of 3.1% this year vs. 2% previously

Just as significantly, the recovery is also becoming more broadly based: 2014 will mark the first year since 2007 that exports, consumer spending and investment will all be growing together – an important sign that the recovery is looking more sustainable

The improvement underway in international growth patterns supports the outlook for Irish exports where recent momentum has been impressive

Meanwhile, the ongoing improvement in the labour market is a key barometer of a better domestic economy.  We note that over half of all the jobs created over the past two years were recorded outside of Dublin, indicating that the labour market recovery itself has a breadth to it that extends beyond the capital

Ø  The Irish recovery dynamic is strengthening.  Following the historical upward revisions and stronger-than-expected first quarter performance revealed in the latest national accounts release, we have upgraded our growth forecasts, and now expect real GDP growth of 3.1% this year.  This is about one percentage point higher than our previous estimate, and we expect a continuation of solid growth of 3.2% in 2015.  We expect the unusually large gap between growth in GDP and GNP of late to narrow, and expect GNP to also grow by over 3% this year and next.

Ø  The main driver of the stronger near-term outlook is a much improved export performance, aided by   the combination of improved growth momentum in Ireland’s main trading partners (especially in the UK and US) and better trends in the pharma-chem sector as the drag from the patent cliff looks to have eased.  From a subdued 1.1% annual gain in 2013, we expect Irish export volumes to grow by around 5% this year.

Ø  While high private and public sector debt levels imply some lingering downside risk to Irish growth prospects over the medium term, the near term risk skew looks more balanced: downside risks come from the potential for further disappointment in the euro zone recovery and from international geopolitical tensions, but recent Irish export momentum has been impressive and an upside surprise from this source is a clear possibility.

Ø  We expect the recovery to not only strengthen but also to become more broadly-based this year.  In addition to positive export growth, we also expect both consumer spending and investment to expand in 2014, marking the first year since 2007 that each of these three key areas of spending will all be growing together.

Ø  Trends in overall consumer spending volumes up to Q1 of this year have been somewhat disappointing. However, having declined by 0.8% in 2013, we expect a return to positive growth of over 1% in 2014, and a further acceleration to 2% in 2015, with more timely indicators on car and non-car retailing as well as consumer confidence broadly pointing to better trends of late.  The expected improvement relative to last year is being driven by the strength in key labour market trends with solidly expanding employment now beginning to underpin better underlying income dynamics for the Irish household sector.

Ø  Building on the stronger-than-expected 2.4% rise in employment in 2013, we expect further healthy increases of around 2% both this year and next.  Such gains in employment will continue to exert meaningful downward pressure on the unemployment rate which we expect to average 11.5% and 10.4% this year and next, down from 13.1% last year and the annual cycle peak of 14.7% reached in 2012.

Ø  Beyond the headline labour markets developments, we take additional encouragement from two other features of the recent figures.  First is the continued strength of full-time employment where annual growth has been above 3% for the past three quarters – an important sign of rising employer confidence in the durability of the recovery.  Second is the evidence that the improvement that is being registered is not confined to Dublin.  While jobs growth in Dublin is outpacing that outside the capital, six of the seven non-Dublin regions have experienced some pick-up in employment over the past two years.  Indeed, over half of the 63,000 net new jobs created in the economy since early 2012 have been recorded outside Dublin.

Ø  Turning to investment, while growth in overall capital formation and its components has been extremely volatile, trends in home-building, non-residential construction and core business capital spending point to the likelihood of total investment reversing last year’s 2.4% fall.  We expect growth of 8-9% in 2014 and 2015 as capital formation makes gradual inroads into recouping the 40% losses experienced over the 2007-11 period.

Ø  The recent improvement in residential activity is particularly welcome, for two reasons.  First, the fact that home-building is now rising and not falling means that one major headwind which had held the economy back over a deep, seven year construction correction has now become a tailwind, thus contributing to both a strengthening and broadening of the wider recovery.  And second, with price pressures building in some areas of the housing market (particularly Dublin), rising supply is badly needed to keep pace with strong demand.

Ø  So far this year, completions are running about 30% higher than 2013 levels nationally indicating that a supply response is now getting underway.  Furthermore, the geographic mix of that supply response is favourable, in that completions in Dublin are up 190% y/y compared with a rise of just 7.5% outside Dublin indicating that new dwellings are now being brought on stream at a faster pace where they are needed most.  The problem is that supply is likely to continue to struggle to keep up with demand, in the short term at least.  Fewer than 1,400 new units were completed in Dublin last year, for example, which falls a long way short of recent ESRI estimates of the medium-term requirement for housing in the capital of around 7,000 per annum.

Ø  Combining price-supportive supply-demand dynamics in Dublin in particular with continued improvement in key underlying labour market fundamentals along with the strong momentum evident in recent trends argues in favour of further solid growth in house prices.  Following a return to positive (2%) growth last year, we expect the CSO residential property price index to rise by a further 10.5% on average this year, and by another 8% in 2015.

Ø  The strengthening of the economy’s recovery dynamic is also benefiting the public finances which were close to Eur1bn (0.5% of GDP) ahead of expectations at end July.  Aided further by the helpful effect of the recent large upward revisions to nominal GDP, this leaves Ireland on track to record an underlying general government deficit of under 4% of GDP this year – well ahead of both the government’s planned 4.8% and the 5.1% ceiling set by Europe.  That would also mark a fourth consecutive year of budgetary outperformance relative to target as Ireland continues her journey back to fiscal balance from the peak underlying deficit of just below 12% of GDP in 2009.  This more favourable deficit profile opens the door for some material easing back on the planned Eur2bn of fiscal tightening in the coming October budget while still getting the 2015 deficit below the long-standing 3% target.

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