Global Insight Perspective | |
Significance | Irish domestic demand has weakened substantially with both consumer spending and investment faltering substantially. Only strongly positive net trade prevented deeper GDP contraction in the second quarter. |
Implications | Major housing market and construction downturns are having a major depressing impact on Irish economic activity on top of wider European problems including the strong euro, elevated oil, commodity and food prices, the financial-sector turmoil, and slowing global growth. |
Outlook | Global Insight currently forecasts Irish GDP to contract by 1.0% in 2008, and then grow by just 0.3% in 2009. However, we are likely to revise these projections down in our October forecasting round. |
Irish GDP contracted 0.5% quarter-on-quarter (q/q) and 0.8% year-on-year (y/y) in the second quarter of 2008, according to the Central Statistics Office (CSO). This followed contraction of 0.3% q/q in the first quarter, meaning that Ireland is now officially in recession. The economy has been slowing significantly since the first quarter of 2007 and essentially only stagnated in the second half of last year.
GNP contracted by a particularly sharp 3.1% q/q in the second quarter of 2008, although this followed growth of 0.8% q/q in the first quarter. Consequently, GNP was down by 2.1% year-on-year in the second quarter. It could be argued in the case of Ireland that GNP is a more realistic indicator of domestic conditions, given the high level of profit repatriation by Irish-based multinationals. However, the q/q GNP data are highly volatile because of this factor.
Consumer Spending and Investment Plunges in Q2
Consumer spending was particularly weak in the second quarter, plunging by 3.0% q/q. This followed a drop of 0.3% q/q in the first quarter and meant that it was down by 1.4% y/y. Consumer spending was supported for an extended period by high and rising employment, healthy earnings growth, and strong house price gains, as well as the substantial release of money from the maturing of SSIAs (government-backed savings schemes). However, these supporting factors have increasingly waned since the first half of 2007. In particular, house prices are now falling markedly, unemployment is on the up, and purchasing power is being squeezed by elevated energy and food prices. Further weighing down on consumption is tight credit conditions, markedly lower equity prices, and higher interest rates.
In addition, capital investment has cooled substantially. Indeed, it plunged by a further 4.3% q/q in the second quarter after sinking by 7.4% q/q in the first. This marked the fifth successive sharp q/q decline in investment, causing it to be down 18.8% y/y in the second quarter of 2008. In marked contrast, it had been 7.1% q/q and 12.6% y/y higher in the first quarter of 2007. The sharp turnaround in capital investment is the consequence of the marked downturn in the construction sector following extended heady growth in recent years. Meanwhile, government spending growth slowed to 1.1% q/q in the second quarter from 1.6%; it was up by 3.9% y/y. Consequently, domestic demand contracted sharply in the second quarter, marking a third successive decline.
The overall decline in GDP would have been much more pronounced in the second quarter, but for a major positive contribution from net trade. Exports of goods and services rebounded by 1.3% q/q in the second quarter after contracting by 1.1% q/q in the first quarter. The rebound in exports in the second quarter was somewhat surprising given the strength of the euro and slowing domestic demand in key foreign markets, most notably the United Kingdom and the United States. However, y/y export growth of 2.4% was substantially below the levels of recent years. Meanwhile, imports contracted by a further 2.4% q/q in the second quarter after falling by 1.4% in the first quarter, reflecting substantially softer Irish domestic demand. Imports contracted by 1.1% y/y in the second quarter.
Industrial Production Dragged Down by Plunging Construction Output
On the output side, industrial production plunged by 0.9% q/q in the second quarter after essentially stagnating in the first quarter, so was up just 1.0% y/y. Industrial production has been increasingly held back since the early months of 2007 by sharply deteriorating building and construction output. This was only flat in the second quarter after sinking 8.4% q/q in the first quarter, causing it to be down 12.2% y/y. Meanwhile, distribution, transport and communications output fell by 2.2% q/q and 4.3% y/y in the second quarter. Output of other services was down 0.5% q/q and up 2.5% y/y.
Outlook and Implications
Latest data and survey evidence indicate that the Irish economy continued to contract markedly in the third quarter of 2008. Furthermore, the economy seems set to struggle for some time to come as it is pressurised heavily by major headwinds. Consequently, we are set to revise down further our September forecast that GDP will decline by 1.0% in 2008. This will be the first contraction since 1986. Consumer spending will be depressed by rising unemployment, a very weak housing market, elevated inflation, relatively high interest rates compared to recent norms, tighter lending conditions and financial market turmoil.
Meanwhile, construction investment will contract substantially in 2008 in reaction to falling house prices and the over-expansion of recent years, thereby dragging down overall gross fixed capital formation. On top of this, business investment growth will be pared in the face of depressed confidence, markedly lower final demand and tight credit conditions. Investment by U.S.-owned multinationals may be further hit by weakened performances in their domestic markets. Government spending growth will also be more modest in 2008, as slower revenue growth hurts public finances. As a result, domestic demand is forecast to contract sharply in 2008.
Meanwhile, net trade is likely to make a reduced contribution to GDP growth in 2008, in marked contrast to the major positive contribution in 2007. This reflects the euro's overall strength against the U.S. dollar and the British pound in 2008 as well as slower global growth. Both U.S. and U.K. domestic demand is seen softening significantly in 2008.
A still-weak housing market and struggling construction sector is seen as being a key factor in limiting the pick-up in activity in 2009. GDP growth is now forecast at just 0.3% in 2009. Consumer spending growth is expected to remain under pressure despite lower inflation, while total investment is forecast to contract further due to still declining construction spending. Meanwhile, net trade is projected to make a relatively modest contribution to overall growth in 2009.