The economic rebound from Covid is now well under way but as we head into 2022 the outlook is still clouded with fresh risks from new variants, concerns about a slowdown in global growth, inflation uncertainty and more trade friction from Brexit. The only sure thing is that the issues that dominated in 2021 look certain to be to the fore again. Here are five potential flashpoints.
Inflation and the cost-of-living squeeze?
The biggest economic debate worldwide right now is whether the current acceleration in price growth and the ensuing cost-of-living squeeze is – as central banks keep telling us – transitory, a product of the post-Covid reopening of economies or something more prolonged, something that could usher in a new era of higher interest rates.
Our entire financial ecosystem – stock markets, company earnings, government bonds, mortgages – is predicated on low interest rates and a significant shift could have far-reaching consequences. Deutsche Bank warns a period of rate hikes could cause havoc in a "debt-heavy world", spurring financial crises in emerging economies.
Prices have skyrocketed in the past few months on everything from home heating and fuel to hotel rooms and airline tickets, fuelled by a massive surge in energy prices globally, a post-lockdown rebound in consumer spending and supply chain bottlenecks. Brexit red tape is also a factor.
Irish inflation is now running at a 20-year high of 5.3 per cent while, in the US, it is over 6 per cent, the highest level since 1982.
US Federal Reserve chief Jerome Powell has – in recent weeks – signalled a shift in the Fed's thinking on the issue. He said it is probably time to "retire" the word "transitory" when describing inflation, while suggesting the Fed could accelerate its unwinding of bond purchases that have helped keep longer-term borrowing costs low.
A faster tapering could prepare the ground for an inflation-cooling interest-rate increase as soon as the first half of next year – rather than the second half as previously expected. Some say the market is already factoring in two US interest rate hikes in 2022.
The European Central Bank (ECB) tends to be less reactive and has so far ruled out an interest rate rise in 2022. Whether the current bout of inflation proves stickier may come down to wage growth. If wages start rising as workers demand better compensation for the current cost-of-living squeeze, that could trigger a wage-price spiral, leading to a more prolonged bout of price growth.
There is also a school of thought that believes the race-to-the-bottom globalisation that we’ve had for two decades, which has effectively exported price growth, may be at an end as businesses rethink their supply chains and consumers demand greater ESG (environmental, social and governance) standards. The debate is set to run.
Escaping the cycle of on-off restrictions
Predicting the end of the pandemic has – to date – proved a mug’s game. We are now officially in wave four of the virus, with the look complicated by the emergence of new, potentially more transmissible strains.
Another complicating factor is large differences in vaccination rates between countries. The Organisation for Economic Co-operation and Development (OECD) has warned that vaccine inequity – particularly in low-income countries – is fuelling renewed outbreaks, which are adding to the unevenness of recovery in the global economy.
Economic normalisation remains vulnerable to further restrictions as virus variants challenge public-health systems. Getting out of this cycle of on-off restrictions is a key challenge for 2022 and a key requisite for businesses in consumer-facing sectors.
On the upside, the severity of the virus continues to moderate as treatments become more efficacious. Pfizer and BioNTech say their booster jab promises to be an effective defence against the Omicron variant. Hopefully the era of circuit-breaker lockdowns is behind us.
While Ireland is experiencing exceptionally strong growth fuelled by an increase in aggregate income and the unwinding of lockdown savings, risks to the consumer-facing sectors from new restrictions and more stringent messaging around social distancing have risen. This points to a K-shaped recovery, with much of the economy reverting to the jobs-rich growth we had prior to the pandemic – the Central Bank is predicting that up to 60,000 jobs will be created over the next two years – while the worst-affected sectors take longer to recover.
Renewed restrictions are likely to see a temporary slowing of recovery in the final part of 2021 and the first quarter of 2022 with an acceleration again in the spring. Not for the first time, the economic outlook is tied to epidemiology.
Removing supports and zombie businesses
Covid has ushered in a new era of crisis management, with wage supports deployed en masse to cushion the economy from the worst of the hit. Such measures stand in sharp contrast to the austerity imposed in the wake of the 2008 crisis, which compounded the the fall-off in demand.
However, weaning the economy and businesses off these supports – a fiscal imperative from the Government's point of view – is likely to prove tricky. The Government has already had to reverse out of a cut in the Employer Wage Subsidy Scheme (EWSS), which it plans to phase out on staggered basis between now and April. Minister for Finance Paschal Donohoe said the Government couldn't design a targeted scheme for the hospitality sector in time for Christmas and so have gone this route instead.
Wage supports have been critical to maintaining the link between employers and employees and it is crucial the Government avoids a cliff fall when removing these safety nets.
The expectation is that they will be in place for longer than April, the current end date, but on a more targeted basis. That said, the final end point will necessitate condemning debt-laden zombie businesses – those being kept alive by supports – to oblivion, an unavoidable aspect of the current crisis. Many fear the true extent of this won’t be known until the tide of supports goes out.
An internal Government memo is warning that tens of thousands of jobs could be lost if the EWSS is removed in April.
Regardless of supports, Irish Small and Medium Enterprises (Isme) chief executive Neil McDonnell says he expects to see an uptick in insolvencies in the first quarter of 2022.
“We’d expect the action to kick off as early as Q1, since the Christmas restrictions will have changed the calculus for a lot of businesses, especially in hospitality, restaurant, pubs, music and entertainment,” he says. “Anecdotally, we heard a lot of businesses planned to trade as hard as possible for December, and then close the doors before the January-February VAT bill was paid. The new restrictions have altered those plans,” McDonnell says.
A positive is that the Government’s better-than-expected tax and deficit numbers, which are expected to continue in 2022, enables State to keep providing support to struggling sectors and businesses.
Brexit and an adverse trade outcome
If the past is the best predictor of the future, we're likely to see more friction between the EU and the UK on post-Brexit trade arrangements but the avoidance of a serious breach in relations. Both sides are trying to reach a deal that would reduce customs checks on goods moving from Britain to Northern Ireland – seen as the key faultline in the current agreement – and ensure the free flow of medicines across the Irish Sea.
The UK government has warned that it will trigger article 16 of the Northern Ireland Protocol if progress isn’t made, although reports earlier this month suggested the ECJ issue had, for now, been taken off the table by the British side.
Article 16 is the legal mechanism allowing either the UK or the EU to take unilateral action if they believe the deal has brought “serious economic, societal or environmental difficulties” or “diversion of trade”.
In response to a UK triggering of article 16, the EU could terminate the Brexit trade deal, sparking a trade war between the 27-nation union and its former member.
Up to now, worst-case scenarios have been avoided but such a stark outcome remains a risk. Brexit has impacted trade between the Republic and Britain but much of it is mixed up with the pandemic and it may be some time before we get a clear picture. While imports from Britain have plunged, the value of goods exports from the Republic to Britain have increased, though there are pandemic base effects driving these numbers as well.
The other big shift is the pick-up in trade North-South. Much of this might be diverted trade as businesses use the North as a channel to move goods between the Republic and Britain.
Despite technology and the removal of trade restrictions across the world, studies continue to show that geographical proximity and economic size are still the dominant factors in trade patterns, even in services. As a result, the UK will remain a dominant export destination for many Irish businesses despite Brexit and despite our economic ties with the US.
Soaring housing prices and rents
A central question is whether a rebound in construction implicit in the Government’s Housing for All strategy, which promises 33,000 homes a year out to 2030, will bring about a change in Ireland’s increasingly fraught housing dynamic.
Demand for housing has strained a dwindling supply of available homes, pushing up prices and rents. Property website Daft.ie said there were just 1,460 homes to rent on its website as of November 1st last, the lowest number since its quarterly series began in 2006. This included just 820 in Dublin.
The Central Bank is also warning that a significant public spend on housing over the next few years could run up against capacity constraints, primarily related to a labour shortage, which may fuel further inflationary pressure in the sector.
There are two fundamental forces fuelling the crisis here: supply and price. One is too low, the other too high. The Government and industry are banking on the old supply-and-demand laws resolving the pricing issue but there is little evidence the housing market conforms to these laws.
It’s almost certain an increase in supply and a waning of the Covid-driven demand for housing will moderate the current levels of price and rent growth in the coming months, but the affordability gap at the heart of the equation is unlikely to change much, suggesting housing is likely to remain one of the chief economic and political flashpoints of 2022.