A host of indicators point to an economy that turned a corner in the first half of this year…

• A surge in the output and exports of the Irish multi-national sector was a major driver of the return to positive quarterly GDP growth in the first quarter of this year.  But encouragingly recent quarters have witnessed emerging evidence of modest improvement beyond the activities of multi-national firms.  The output of ‘traditional’ segments of the manufacturing base, including the food and beverage sector for example, is now also in recovery mode.  In addition, overall consumer spending is almost certainly going to record a positive second quarter, reflecting not just a pick-up in car sales but also the fact that ex-motors sales volumes have managed to grow by 1.1% in each of the first two quarters of this year.  This marks some underlying improvement that is consistent with a gradual ongoing improvement in consumer confidence.

• These improvements lead us to revise up our economic forecasts for this year, which now envisage average annual GDP growth of +1%, up from -0.5% previously.  GNP is somewhat weaker, partly reflecting the strength of MNC profit outflows, though we have made upward revisions here too, with growth on this metric now expected at -0.4% from -1.2% previously.

…but a continuation of the export-led Irish recovery is critically dependent on the international outlook, where downside risks have risen lately

• The export-led recovery now underway in Ireland reflects the pick-up in the global economy which has been in recovery mode for over a year now. However, it would be wrong to assume that the domestic recovery will be plain sailing from here. Corrections in property markets and the public finances are ongoing while there have been signs of a stalling in the positive trends in core retail sales in the most recent couple of months. previously.

• Of more concern are the indications of a slowing global economy, notably in the US where a series of recent economic numbers have disappointed to the downside.  Our base case is that the global recovery will remain broadly on track, albeit at a gradual pace.  On this basis we forecast a continuation of the export-led recovery which should promote improved domestic confidence and ultimately provide the platform for a recovery in domestic demand, beginning next year. An improvement in Irish competitiveness is also supportive of the Irish export dynamic, as reflected in declines in domestic costs and prices, in both absolute and relative terms, as well as recent declines in the euro’s value against the dollar and sterling.  Overall, we are projecting average GDP growth in 2011 of around 3%.  Nonetheless, the downside risks facing the international outlook have risen lately, and these will require very careful watching as without the critical support from external demand, it is very difficult to see the Irish recovery staying on track.

Unemployment rate now close to peak, but no quick fix in sight for the jobs crisis

• On the jobs front, the labour market is set weaken further in the short term: employment probably has further to fall, though at a reduced pace compared with heretofore, while the unemployment rate is set to peak between 13.5 and 14% later this year, from 12.9% in Q1.

• The international experience of the lags between the return to positive economic growth and employment gains over the past year points to the possibility of some slight net job creation here by the end of this year.  However, the nature of the early stages of the Irish recovery, driven as it is by exports, argues against much of an early uplift in employment.  Export growth is not labour-intensive, a point highlighted by the fact that there was very little direct net job creation in exporting firms over the pre-crisis years of 2002-2007 – a period of relatively buoyant demand in Ireland’s key trading partners. Nevertheless, any increase in employment would be extremely welcome following a downturn which has seen the economy shed over 270,000 jobs, and a more stable employment situation may see the unemployment rate edge lower next year, aided by further falls in the labour force.

The Irish government is a “credible deficit reducer” but Anglo recap costs weigh very heavily on investor sentiment as this year’s headline deficit number could get extremely ugly

• Turning to the public finances, the fiscal correction has entered its third year and the considerable progress to date means that in our view the Irish government has established itself as a “credible deficit reducer”.  This year’s underlying fiscal targets are broadly on track reflecting assertive control of government spending and an improving trajectory for growth in tax receipts.  However, the scale of the deficit means that several more years of fiscal tightening are in prospect and it remains a key policy priority that budgetary targets continue to be met in order to avoid a Greek-style outcome for the Irish public finances.
   
• While the underlying fiscal situation looks to be unfolding in line with expectations, the same cannot be said of estimates of the budgetary cost of recapitalising the banking sector which have continued to ratchet higher.  This is particularly so in the case of Anglo-Irish Bank which on some recent official estimates could end up costing the State some €25bn, and possibly more on the more pessimistic estimates of some private sector analysts.  The extremely large costs involved, as well as ongoing uncertainty about what the true final cost will ultimately amount to, are weighing heavily on investor sentiment in Irish government bond markets where spreads relative to Germany have widened out to new crisis highs in recent days.
  
  
• Depending on how events unfold in the months ahead, as well as the statistical treatment of further injections into Anglo, such outlays could result in a spectacularly ugly headline budget deficit number for this year, maybe of the order of mid-20s% of GDP and perhaps even higher in a truly extreme scenario. Without seeking to play down how ugly a prognosis that represents, it is critical to recognise that the banking sector injections are non-recurring.  Thus, while there clearly will be a considerable additional debt burden arising from the state outlays in Anglo, for example, the path back to the target for the underlying deficit of 3% by 2014 is unaffected.  Indeed, the underlying deficit most likely peaked last year at 12.1% and on our forecast will fall to 11.4% this year and towards 10% in 2012. Nevertheless, it is extremely important for the Irish authorities to provide clarity as soon as possible around the future plans for Anglo, and the ultimate total cost thereof to the exchequer.

Aidan McLaughlin
Senior Client Manager
Fleishman-Hillard |  Digital. Integrated. Global.

(T) +353 1 618 8425 | (M) +353 85 749 0484 
(E) aidan.mclaughlin@fleishmaneurope.com (I) www.fleishmaneurope.ie