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| Dr. Alan Barrett |
Irish public finances will end the year in deficit as a result of a slowdown in the economy, while house prices will fall 3 per cent, according to forecast published today.
An estimated 17% of direct tax revenues came from the property/construction sector in 2006.
The Economic and Social Research Institute (ESRI) in its Quarterly Economic Commentary Summer 2007 (QEC), is forecasting a change from an Exchequer a surplus of 2.2 billion in 2006 to a deficit of 622 million this year, worsening to 1 billion next year.
The ESR says that as the housing boom ends, Gross Domestic Product (GDP) growth will slow to 4.9 per cent this year and fall to 3.7 per cent in 2008.
The ESRI has reduced its forecast for the property market and says that average house prices will drop by 3 per cent this year.
Investment in housing will fall 4.7 per cent this year and by more than 6 per cent next year, it is forecasting.
The ESRI is projecting that average consumer price inflation will decelerate from 4.9 per cent this year to 3.0 per cent in 2008. However, the forecast is based on an assumption that that only one further European Central Bank rate rise of 0.25% to 4.25% is on the horizon while other forecasts range from a peak of 4.5%-4.75% in 2008.
The ESRI forecast of the Exchequer outlook is based on the Department of Finance view that current public spending can be held to a growth rate of 6.5 per cent next year, compared with the 12.7 per cent public spending growth rate expected for 2007.
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| Dr. Ide Kearney |
ESRI economist Dr. Alan Barrett said that more subdued rates of economic growth would not be catastrophic and should be seen as a return to a more sustainable economy.
However, he warned that the economic slowdown could be more pronounced if high inflation rates result in pressure on wages.
Unemployment, which ran at a rate of 4.4 per cent in 2006, will increase to 5 per cent next year.
A less buoyant construction industry will mean employment growth will fall from 87,000 new jobs in 2006 to 58,000 this year and 25,000 in 2008.
The ESRI forecasts that migration of workers will also fall, with net immigration falling from 70,000 last year to 50,000 in 2007, before halving to 25,000 next year.
Barrett said it was critical that the economy shifted away from construction and focused more on the services sector and other industries.
But he said the Government had little scope to help the economy along its transitional path because its ability to ensure that wages remained flexible was limited.
Housing Market
A research paper by UCD Professor Morgan Kelly, published by the ESRI with the Quarterly Economic Commentary, suggests that a correction in the property market could be more severe, with prices falling by 5 per cent each year for the next decade.
Property markets can move from booms to busts very suddenly, Kelly warned.
Kelly says that up to 60 per cent could be wiped off the real value of houses over the next eight years if the Republic's housing market follows the same pattern as those in other countries.
He says that the housing market could go into rapid freefall, with house prices falling by 5 per cent per annum over the best part of the next decade.
Adjusted for inflation, this would translate into an annual fall in real average selling prices of 6-7 per cent or 40-60 per cent over the next eight to nine years.
The bigger the boom in house prices, the bigger the subsequent bust, he said.
As long as there is a large stock of unsold houses and falling prices, potential buyers will have an incentive to wait for further price declines before they buy, according to the paper.
Kelly looked at up to 40 property booms and crashes that have occurred in Organisation for Economic Co-operation and Development (OECD) countries since 1970.
"Typically, real house prices give up 70 per cent of what they gained in a boom during the bust that follows," he says.
A housing bust in the Republic has the potential to be even more severe than those in other OECD countries because of the strong growth in the number of new houses built here in recent years and because 15 per cent of the housing stock currently lies empty.
House prices have fallen 2.1 per cent in the first five months of the year, according to the latest figures from the Permanent TSB/ESRI house price index.
Average national prices have now fallen for three months in a row and are expected to show further falls.
Professor Kelly says that the impact that a collapse in house prices would have on the construction sector is the principal cause for worry.
In most economies, the housing sector accounts for only 5 per cent of gross domestic product (GDP), but in the Republic, that figure is 15 per cent, the paper says.
The ESRI said house completions would fall to 82,000 in 2007, down from 92,000 last year, and then fall to 76,000 in 2008.
Some of the main findings of the QEC Summer 2007 analysis include:
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The ESRI expects a moderation in the pace of economic growth in 2007, with real GNP growth of 4.8 per cent. Growth in consumer expenditure is anticipated to slow in 2008, following a strong SSIA-fuelled performance in 2007. This slowdown contributes to its forecast of a further reduction in real GNP growth next year, with growth of 3.7 per cent anticipated.
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While these rates of growth are lower than that experienced in 2006, they should be seen as a return to sustainable rates.
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Housing investment is expected to fall by 4.7 per cent in 2007 and by 6.1 per cent in 2008.
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The slowdown in economic growth will impact on the public finances, with growth in current revenues halving in 2007 relative to 2006. The ESRI forecast for the Exchequer Balance shows a deficit of 1 billion in 2008, a deterioration of 3.3 billion on 2006.
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The trade balance continues to decrease as the growth in imports is expected to outstrip that of exports in 2007 and 2008, despite a favourable international setting. This contributes to the current account deficit widening to over 5 per cent of GNP in 2008.
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The ESRI expects employment growth of 2.9 per cent in 2007, slowing to 1.2 per cent in 2008 driven by a deceleration in construction sector employment growth. Net immigration is anticipated to fall to 50,000 in 2007 and 25,000 in 2008. The projections imply an unemployment rate of 5 per cent in 2008.
In a General Assessment of the economy, the ESRI looks at the challenges facing the economy which is now entering a stage of transition as the housing boom ends.
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As the housing boom comes to an end, the economy must move resources to other areas of economic activity, such that the transition is as smooth as possible in terms of output and employment. We are optimistic that a smooth transition will occur and this is reflected in our forecasts for services and industry growth. However, if the current high rate of CPI inflation feeds into excessive wage demands, this could endanger a smooth transition.
