Ulster Bank Irish Economic Outlook – February 2011

Recovery process underway, driven by strongest export performance in 10 years

• For a small, extremely open economy like Ireland where exports amount to 90% of GDP, the early phases of cyclical recovery generally tend to stem from an uplift in global economic conditions.  That dynamic is clearly playing out in the case of Ireland which is visibly benefiting from an international recovery which is almost two years old. 
  
• Export growth has been an extremely important bright spot in the Irish economic landscape and is estimated to have reached 10% in 2010 – the fastest growth since 2000.  Several aspects of this performance offer important encouragement: export gains have been larger than most forecasters had been expecting, are outperforming most other advanced economies, are becoming more broadly-based and are beginning to generate some positive job creation.
  
• The positive contribution to overall economic growth from the traded sector is coming through in the trends in aggregate measures of the economy’s output with both GDP and GNP recording quarterly gains in two of the past three quarters.  For 2010 as a whole, it looks like the economy may have contracted very marginally in GDP terms (-0.3%) following the 7.6% collapse in 2009, with the sharp change in trajectory indicating that relative stability returned to the economy last year following the plunge at the height of the recession.  GNP continues to under-perform - in part reflecting profit outflows from a buoyant multi-national sector - and is estimated to have fallen by 2.1% last year, albeit a much slower pace of decline vs. the 10.7% nose-dive seen in 2009.

Intensification of the fiscal correction will hamper, but not kill off, recovery momentum

• One key international development from an Irish perspective is the reacceleration in global activity which has emerged in recent months, notably in the US where growth expectations have been revised higher lately helped by recently announced fiscal and monetary stimulus measures.  This offers critical support for the Irish economy as we look forward, even if the pace of export growth is set to moderate somewhat this year, as the post-crisis snap back in global trade volumes fades.
  
• As encouraging as the health of the export sector is, overall prospects for the economy are importantly affected by the ongoing fiscal retrenchment.  The required adjustments both for 2011 and for the multi-year period to 2015 have doubled relative to expectations six months ago.  This additional fiscal tightening has a major bearing on the outlook for domestic demand, which is set to fall for a fourth consecutive year in 2011 reflecting further weakness in consumer, business & construction and government spending. 
  
• But despite the ongoing declines in these areas, the strength of net trade is such that overall economic growth will record a return to positive territory this year.  We expect GDP growth of 1.2% and weaker GNP growth of 0.1%, albeit that these projections are some way weaker than the 2.5-3% estimates that seemed plausible six months ago prior to the resizing of the fiscal correction.  Moreover, the absence of a recovery in domestic demand in 2011, despite the expected rise in GDP, means the early stages of this recovery will lack a feel-good factor for most households and domestic-facing businesses.  
  
• While some areas of domestic demand may begin to stabilise later this year, it will be 2012 before business and consumer spending can return to positive, though very modest, rates of expansion on a full-year basis.  This expected broadening of the economy’s improvement should result in a further moderate pick-up in growth momentum in 2012 when we expect GDP growth of 2.4% (1.6% for GNP).

But sluggish growth prospects mean progress in restoring lost output and employment will be painfully slow

• The expected improvement in the economy’s growth dynamic is extremely welcome.  However, the recovery scenario that appears likely at this stage needs to be seen in the light of the extremely heavy losses in output and employment experienced over what was an extremely severe recession.  In total, real GDP, for example, slumped by over 14% from its peak in Q4 ’07 to its low point in Q4 ’09.  On a base-case scenario of a return to average growth rates of around 2.5% in the coming years, it will take the economy some eight years to merely recover the output lost over the downturn.  Interestingly, the US economy – itself experiencing a sub-par recovery - has just reached that particular milestone.  It took the US three years (from Q4 ’07 to Q4 ’10) to see GDP return to its pre-crisis level, highlighting the relative weakness of the Irish recovery dynamic.
  
• One implication of a sluggish recovery is that it will be difficult to make significant inroads into the unemployment problem.  This is especially the case in the early stages of the recovery which are being driven by export growth which is not labour intensive. 
  
• But there are some tentatively encouraging signs on the labour market beginning to emerge.  The unemployment rate looks like it peaked below 14% last summer, with the latest Live Register estimate recording some slight declines in recent months to take it to 13.4% in January.  There is little doubt that the stabilisation in the jobless rate is linked to ongoing declines in the labour force reflecting both outward migratory flows and greater participation in education.  However, we are also beginning to see some early signs of slight improvement on the demand side of the jobs market.  Net employment in the multi-national sector rose in 2010, indicating that the export resurgence is starting to generate real-economy impacts, while there has also been a modest uptick in new job vacancies relative to year-ago levels, pointing to the possibility of some slight improvement in employment prospects later in the year. 
  
• But our forecasts envisage that employment will fall again on average in 2011, with a 1.2% drop at least representing an easing in the pace of decline relative to 2010 when it fell by an estimated 4%.  The beginnings of a recovery in domestic demand in 2012 should help foster some modest employment gains next year of 0.5%, though this outlook is likely to result in rather modest downward pressure on the unemployment rate which we expect to average 13.2% and 12.6% in 2011 and 2012 respectively, from 13.3% in 2010.

Simon Barry,
Chief Economist, Republic of Ireland
E- mail:  Simon.Barry@ulsterbankcm.com
Tel: + 353 1 643 1553
Mobile: +353 86 3410142

Lynsey Clemenger
Economist
E-mail: Lynsey.Clemenger@ulsterbankcm.com
Tel: + 353 1 643 1565