Central Bank predicts economy to remain in recession for two years

THE ECONOMY will remain in recession for at least two years, shrinking by 1.4 per cent this year and contracting by a similar degree in 2009, the Central Bank warned yesterday.

A further correction in the housing market and the ongoing crisis in financial markets will keep economic growth in negative territory, the bank said in its latest quarterly bulletin. The unemployment rate will rise to 7.5 per cent next year.

Central Bank assistant director general Tom O'Connell called for a tough budget, saying it was "vital that fiscal prudence be maintained" in the "challenging" economic environment".

"Difficult decisions and choices will have to be made," he said.

By forecasting a contraction of 1.4 per cent gross national product (GNP) and 0.8 per cent gross domestic product (GDP), the Central Bank has substantially revised downwards its assessment of the Irish economy since its last quarterly bulletin in July. At that time, it predicted that the economy would grow by 0.3 per cent in GNP terms, with 1.8 per cent growth pencilled in for 2009.

However, over the summer there was a sharp deterioration in public finances and the numbers of people on the live register of unemployment benefit claimants spiked. The escalation of the unprecedented turmoil in the financial markets will also have spillover effects on the real economy.

"The scale of the adjustment has been greater than most people expected," Mr O'Connell said.

"The size and speed at which the public finances have gone from healthy surplus to deficit is a cause for concern."

The Government should now rein in spending, and avoid any significant expansionary fiscal measures in the budget.

"It is easier to correct imbalances if action is taken early," he said, while a large deficit would "obviously have to be repaid by taxpayers eventually" in any case.

Mr O'Connell said the State had built up a reputation for pursuing prudent fiscal policies in recent decades, helping it attract foreign direct investment and spur growth. "Running high deficits at this juncture would damage this reputation."

The general Government debt would be 5 per cent this year and "maybe similar next year", he said. "But obviously a lot depends on the budget."

The adjustment in the housing market would continue into 2009, said the Central Bank.

House prices, which have fallen 13 per cent since their peak in February 2007, "still have some way to fall", while the number of houses built next year would be roughly half the number that would be completed this year.

Consumer spending, which grew by 6.3 per cent last year, would be flat in 2008 and 2009, with just marginal growth of 0.4 per cent in both years, the bank said.

The persistently high Irish inflation rate had reduced the purchasing power of consumers. However, inflation was expected to ease next year.

The last time Ireland recorded full-year negative economic growth was in 1983, after which the economy remained weak into the 1990s. However, Mr O'Connell said Ireland was now in a much stronger position to recover.