Domestic capacity constraints to restrict economic growth, Central Bank warns

The Central Bank has downgraded its growth forecasts for the Irish economy, citing domestic capacity constraints and the impact of tighter monetary conditions in the wake of 10 consecutive interest rate hikes from the European Central Bank (ECB).

In its latest quarterly economic bulletin, the bank said it expected the domestic economy as measured by modified domestic demand (MDD) to grow by 2.9 per cent this year against a forecast of 3.7 per cent as recently as June. In terms of gross domestic product (GDP), it expected the Irish economy to expand by 2.9 per cent against a previous estimate of 5.3 per cent.

Driving this revised outlook were capacity constraints in employment and housing, the regulator said.

“Employment growth is forecast to slow in the coming years as capacity constraints in the labour market and broader economy limit the scope for expansion in the labour force,” it said.

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“The economy has reached full employment, enabled by inward migration and measures of labour market slack are low. The pace of jobs growth is forecast to slow in the coming years as capacity constraints, including housing supply, bind further,” it said.

The transmission of tighter monetary policy is also expected to play an increasing role in containing demand conditions.

In light of recent revisions to the growth data for last year, which indicated the domestic economy grew more rapidly than originally estimated, the Central Bank said the “excess” savings accumulated by households during the pandemic that support consumption and investment in the future are lower than previously estimated.

“As a result, the potential for upside risk to the consumption outlook is diminished,” it said.

“Overall, with the domestic economy having grown more strongly than previously thought in 2022, the capacity of the economy to sustainably increase the supply of goods and services in line with underlying demand conditions is diminished,” it said.

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“The result of this is slower growth in MDD over the forecast horizon in this bulletin, and marginally more upside risk to the inflation outlook,” it said, noting the Government’s budgetary package – expected to be in the region of €11 billion – could end up keeping inflation higher for longer.

While the outlook for global growth has modestly improved in recent months, it remains weak by historical standards, the Central Bank said, noting Irish export growth has been muted in the first half of 2023, in both exports out of the State and contract-manufacturing exports undertaken abroad on behalf of Irish resident multinational enterprises (MNEs).

It highlighted a slowdown in cross-border pharma exports from Ireland, suggesting it “likely reflects a reversion to more normal levels of activity, which had been boosted by pandemic-related production, in particular for vaccines”.

Regarding the information and communications technology (ICT) in the State, it warned there may be more fundamental cyclical and structural issues at play, with “the higher interest rate environment, lower growth prospects in China and potential trade fragmentation weighing on growth”.

“Going forward, there remains significant uncertainty around the precise path for export growth, the contribution of net exports and foreign-owned MNEs to GDP growth, and how that will influence corporation tax receipts in the years ahead,” it warned.