Irish Central Bank Governor John Hurley

Domestic demand was the main source of Irish output growth in 2006, according to the Annual Report of Ireland's Central Bank. Governor John Hurley said that construction spending was still a major contributor, although it is clear, in retrospect, that housing completions reached a peak last year and are declining towards a more sustainable level.  Consumption growth also remained strong in 2006, buoyed up by the continued growth in employment and earnings.  In contrast, export growth was quite muted.  The volume of exports of goods and services grew by just 4.4 per cent, mostly due to trade in services.  This implies a decline in Ireland’s share of world trade. 

Hurley said that another feature of last year was the further increase in the current account deficit on the balance of payments.  The latest CSO data indicate that the deficit reached nearly 5 per cent of GNP last year.  This indicates a need to rebalance growth.  Some of this rebalancing will occur, as a matter of course, as the growth in consumer spending is expected to moderate next year.  This is likely to result in reduced import growth.  A recovery in export growth is, however, also required as a part of this rebalancing.   In the long run, in a small open economy like Ireland, continued growth in incomes and employment depends, to a significant extent, on a satisfactory performance by the traded goods sectors.  The Governor said that in this regard, there are welcome signs of a somewhat improved export performance in the first quarter of this year but we need to see further data in the coming months before we can be confident that a sustained improvement is taking place.

Last year was a very good one for the public finances.  The strength of growth helped to boost revenues resulting in a General Government Surplus of 2.9 per cent of GDP, one of the best performances in the European Union.   Some of the strength of revenue, however, reflected the composition of growth, with construction and the property market contributing significantly.  This factor was taken into account in framing the fiscal forecasts for 2007 in the context of the last Budget.

There were also important developments in the price of residential property last year.  Hurley said that current developments are more consistent with stability in the market.  Looking forward, it is important to recall that the major underlying factors supporting the demand for housing are employment growth, increases in incomes, demographics and social changes.  

"The prospects for these key factors remain favourable, even allowing for some moderation in the growth rate of the economy, and we continue to believe that the most likely scenario is a soft landing for the housing market," the Governor said.

Hurley said that there has also been a welcome deceleration in the rate of growth of credit in the economy, though it is still at high levels.  The rate of growth in overall private sector credit has fallen from over 30 per cent in June of last year to just under 21 per cent in May of this year.  The rate of increase in mortgage credit growth has also decelerated from a peak of over 28 per cent in March 2006 to about 20 per cent this May.  If this trend continues, the growth rate in mortgage credit should be substantially lower at the end of the year.

Turning to the outlook for the economy generally for this year and 2008, the Bank’s current projections are that output growth will moderate, though still remaining strong.  Overall growth this year is expected to be about 5 per cent, in terms of both GDP and GNP. The data for the early part of this year suggest that growth was probably in excess of these levels but there are two factors that will act to reduce growth somewhat as the year progresses and into next year.  These are the impact of the gradual decline in house building towards sustainable levels and a moderation in consumer spending growth. In spite of the deceleration in growth and a modest rise in unemployment, the projected growth rate for next year, at about 4 per cent, remains favourable by comparison with other economies with broadly similar level of incomes.  HICP ( EU measure - Harmonised Index of Consumer Prices - excludes mortgage rate changes) inflation is projected to ease from an average of 2¾ per cent this year to about 2¼ per cent next year.

The Bank says in its report that there are also some domestic vulnerabilities.  The house building sector, though currently reducing its output, is still large – as a share of activity - by international standards.  A sharper than expected contraction in housing output cannot be completely ruled out, particularly in the event of a greater than anticipated downturn in the economy that affects employment and incomes.  There has also been a recent deterioration in competitiveness and measures should be taken now to reverse this trend, in order to avoid a more serious situation emerging in the future. 

Key elements in this regard would be to continue policies and behaviour which maximise productivity growth and limit inflationary pressures, for example, by investing in infrastructure, providing a framework that fosters R&D and promoting increased levels of competition in the economy.   While many of these measures require action at national level, in practice, productivity improvements ultimately take place at enterprise level, making it essential for public and private enterprises to focus on efficiency in their operations in an increasingly globalised environment, the Bank said.