As Irish economy teeters on the brink of recession, will there be a hard or soft landing?

The Irish economy now stands on the brink of a recession. Headline growth has flatlined (modified domestic demand, the Central Statistic Office’s bespoke measure for the Irish economy, was zero in the third quarter) on the back of ongoing cost-of-living issues, rising interest rates and a slowdown in global economic activity.

GDP (gross domestic product) is already in reverse on the back of a slowdown in multinational exports.

The road up ahead diverges. One path, we’ll call this the “soft landing” route, will see slow or anaemic growth for two or three more quarters, possibly even a shallow recession, as the full impact of the European Central Bank’s (ECB) 10 consecutive interest rate hikes play out and as weaker growth internationally continues to dampen trade.

On the upside this path will see further falls in headline inflation, perhaps to below the ECB’s target rate of 2 per cent, followed by, or in conjunction with, monetary loosening (interest rates coming down). The ECB had been forecast to start bringing down interest rates at the end of the second quarter of 2024 but the quicker-than-expected fall in inflation has led to speculation this could begin earlier, possibly at the end of the first quarter.

ECB policymakers will want to see a concrete and indisputable fall-off in wage growth, the chief driver of inflation in the services sector, in the first quarter of next year before taking their collective foot off the interest rate pedal.

Either way as inflation recedes and interest rates are reduced, demand will pick up again and more healthy levels of growth here and across the euro zone will resume. Under this scenario the Irish economy can return to the growth sweet spot of recent years, characterised by jobs-rich expansion and a sequence of fiscal surpluses facilitated by windfall corporation taxes.

Ibec’s head of national policy and chief economist Gerard Brady noted in a recent report that “since 2019 the story of the Irish economy has been exceptional among developed economies in terms of enormous growth in both exports and large-scale investments. This has culminated in the creation of 350,000 jobs, the strongest period of employment growth in the history of the State. These achievements should not be downplayed.”

The “soft landing” scenario is now the dominant economic narrative. It underpins the macroeconomic outlook presented by nearly all agencies here from the Economic and Social Research Institute, the Central Bank of Ireland, the Irish Fiscal Advisory Council, even the Government itself. They are all predicting a slowdown in headline growth that continues into next year followed by a pickup in activity later in 2024 linked to lower inflation and the unwinding of interest rate hikes.

There are two basic truths about economic forecasting, however. First, most forecasts tend to say the same thing (understandably as forecasters have an inherent bias towards what they’re witnessing right now or what’s just happened). Second, history tells us that almost all forecasts are wrong.

Combine this notion with the fact that we have for the past three years been limping from one crisis to the next: Brexit, Covid-19, Russia’s invasion of Ukraine, inflation and now the Hamas-Israeli conflict.

Next year also promises to be the most politically turbulent year in decades with more than 40 elections scheduled, starting with Taiwan in January and culminating with the US presidential vote in November. The latter could see the return of Donald Trump to the White House, ushering in greater levels of US isolation, global trade tensions and most worryingly a sea-change in the pattern of the Ukraine war.

Now we’ve arrived at the second path, where the road diverges into a more protracted period of flatlining growth or even a prolonged slump.

Outside of the political uncertainties there are two big economic ones. First, the possibility of an inflation surprise, a sting in the tail that would necessitate interest rates staying higher for longer. The second relates to the impact of interest rates themselves: what if the cure for inflation becomes worse than the disease?

Controlling inflation by hiking up interest rates is a blunt tool like deep sea fishing, it ensnares too much marine life, damaging the ecosystem. Interest rate hikes dampen the spending power of consumers and businesses en masse, triggering a slowdown in activity. Overshoot and you can trigger a deeper recession than intended.

There is also a lag factor. The impact of ECB decisions made a year ago are only now emerging, meaning Frankfurt won’t know if it has gone to far with its interest rate bazooka until well after the fact. Even if interest rates fall in 2024 another 75,000 households here will come off fixed-rate mortgages and face into big increases in their monthly repayments.

In 2007 most commentators expected a moderate fallout from the US housing downturn; instead the global economy pirouetted off a cliff. Maverick British economist Bernard Connolly argues the current consensus around a soft landing is similarly misplaced and that central banks have been fanning crises – facilitating periods of rapid, unsustainable growth and asset bubbles via cheap money followed by crashing downturns – for more than a quarter of a century. He believes the current interest rate framework will have a bad ending. Time will tell.

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