Central Bank is concerned about housing oversupply, writes Marc Coleman, Economics Editor

The Central Bank has said it will step up its monitoring of the economy. The bank's governor, John Hurley, said that the economy was currently financially stable, but added that the bank would be concerned about any prolonged pick-up in house price inflation.

He also said that as the maturity date for SSIAs drew nearer, the bank would increase its monitoring of what consumers did with their released money.

The Central Bank is also introducing stress-testing exercises next spring to more systematically measure risks in the financial sector.

Speaking to The Irish Times after the bank published its latest annual Financial Stability Report, examining the vulnerability of the economy to shocks such as interest rate rises and economic downturns, Hurley said it would be a matter of concern if the growth in personal indebtedness did not begin to decline soon after a projected decline in housing demand in the medium term.

Hurley said the contribution to economic growth from the construction sector was strong, but added that this was to be expected under present circumstances. "Undoubtedly, the contribution of construction is high, about twice the European average," he said.

He added that this contribution would reduce as housing demand eased. "The number of houses being built was about 77,000 last year and possibly similar this year. This is clearly higher than the requirements of the economy into the medium-term.

"We would see a requirement for 50,000 in the medium-term."

If the reduction in demand were gradual, the economy would continue to be sustainable, but the employment effects of such a reduction were uncertain, he said.

"Employment in construction is very strong, commensurate with the contribution of construction to the economy. As housing construction comes down, we still see a significant demand for infrastructure and we suspect quite a lot of the slack will be taken up.

"But it's difficult to be certain about that. The requirements in the two sectors aren't quite the same."

In the wake of recent evidence that house price growth is picking up, Hurley warned that the Central Bank would be concerned about any return to growth rates that exceeded the rate of economic growth.

"Last year, house prices were growing by 12 per cent and I indicated in the course of a press conference that I hoped that house price growth would come down to something close to growth in national income," he said. "I think that I mentioned a figure of 6 per cent."

A recent forecast by AIB Global Treasury suggested that house prices are presently growing by 7 per cent. Hurley said that, in spite of any temporary upturn, the long-term trend in house price growth remained downwards.

"We're hoping that the trend continues to be downward. However, if that's not so and if prices were to increase again, that would undoubtedly increase our concerns for stability in the light of the international situation and whatever risks are realised from it."

Turning to personal indebtedness, Hurley said that, although the bank was concerned about the rate of growth in borrowing, it was hard to identify a level of personal debt that would be dangerous for the economy.

"In terms of thresholds for personal debt, there is a threshold below which debt is very good for economic development. Likewise, there is a threshold above which it undoubtedly increases the vulnerability of the economy.

"It's difficult, not just in this economy but in other economies, to determine where that threshold is and, in the absence of the threshold, you have to focus on the types of measures in the Financial Stability Report."

The latest Central Bank monthly credit statistics indicate that personal borrowing is growing at 28 per cent and the Financial Stability Report has predicted that personal debt will reach 150 per cent of personal disposable income over the next two years.

Hurley said there were good reasons for increasing debt levels. "Among these would be high employment levels, increased disposable income, falling inflation and low interest rates," he said.

"While these are expected to continue to be favourable, there is a risk that some of them will disimprove. Given that we're an open economy trading in an open marketplace, our vulnerability is increased. In that situation, debt has to be repaid."

The Central Bank would be concerned, said Hurley, if the expected future decline in housing demand did not result in slower borrowing. "Until such time as volumes start to reduce, the overall level of indebtedness will be stubbornly high. I think, as volumes start to fall from the 77,000 units being built presently, then with a lag you should start to see indebtedness reducing. Until we see that happening, we will remain concerned."

In the meantime, he said the Central Bank was actively engaged with commercial banks to monitor the sustainability of their lending. "There are roundtable meetings with credit institutions discussing the issues and trying to increase awareness.

"The stress-testing exercise is planned to commence shortly, in the spring of 2006, and this is a very important instrument for supporting financial stability. There are also significant consumer awareness campaigns, informing them about the risks of getting into debt.

"Apart from that, you have on-site and off-site monitoring of banks involved in mortgage lending."

The governor said the level of equity withdrawal - the conversion of housing equity into cash - was likely to be small in Ireland, but said that information on this needed improvement.

"We don't have a great deal of data on equity withdrawal. From the information we have, we don't think that equity withdrawal is a significant part of this issue.

"If it were to happen, it would be an issue and would exacerbate the situation, but we haven't seen significant developments in that area.

"But the information base for this is not good, we're trying to improve it continuously. I think it is desirable to improve the quality of all aspects of the data in this regard. This is being discussed with the banks."

The economy's stability was not unduly threatened by SSIAs, according to the governor. But he said that closer monitoring of consumer behaviour would be required in this regard as the maturity of SSIAs approached.

"On the basis of survey evidence, it is our view that a good part of the SSIAs will continue to be saved or will pay down debt. There will be some increase in consumption, but our assessment is that this should not be significant.

"Clearly, this is an area that needs to be continually assessed, particularly as you get closer to the event, because intentions might change."