ANALYSIS:The bond-trading herd shrugged off the week's poor economic indicators and kept buying Irish State debt, but sentiment can change quickly and international perception of small countries is notoriously fickle

THIS HAS not been good week for hopes of economic recovery. New numbers on the most fundamental measures of economic performance – output and employment – were published yesterday and on Wednesday. They were, respectively, awful and bad.

The shake-out in the labour market continued into the second quarter of the year. The slide in the numbers at work was not only in line with the grim trend over the past 18 months, it was broad-based sectorally. In the few industries that did add jobs, the net increases were much too small to offset continued employment contractions in construction, banking, property and retailing.

It is something of an iron law of economics that employment lags output by half a year or so. If that law holds, sustained jobs growth won’t begin until next summer at the very earliest.

Yesterday’s output figures were bad. They were a mess too. Paying attention to headline output rates, such as gross domestic product and gross national product, is increasingly meaningless owing to the growing impact of multinationals’ cash movements into and out of the economy, and the figure-distorting effects of investment decisions in the aviation sector.

That is an issue for economics nerds and need not detain us here. Much more important are the depressing component parts of the output numbers. Just like the employment figures on Wednesday, whatever way you break down yesterday’s data, there are few signs of strength and many points of continued weakness.

In short, the domestic economy remains crippled and the export engine is spluttering.

Despite all of this, faith in the Irish economy among the investment community has not been shaken. The near miraculous rally in the Irish Government bond market, the latest phase of which dates from the European Central Bank’s bond-purchase announcement two weeks ago, continued over the past two days.

The bond-trading herd shrugged off the week’s poor economic indicators and kept buying Irish State debt. Bond yields are back where they stood before the run on the Irish economy began in September 2010.

There are some good reasons for this. The decision taken in Brussels on June 29th to federalise euro area bank regulation and the costs of bank busts is of potentially huge significance for Irish public debt sustainability. The announcement in Frankfurt on September 6th means a sovereign liquidity crisis should never become a sovereign solvency crisis.

Neither measure will prevent insolvency without sustained economic growth. Even the most generous possible deal on bank debt will not change the debt sustainability game if the economy flatlines or shrinks further.

This will dawn on bond traders sooner or later if output and employment continue on their trajectories to mid-year. And change of sentiment can happen quickly. International perception of small countries is notoriously fickle, as Ireland’s four separate crisis phases illustrate.

During the first phase from September 2008 until the middle of 2009, Ireland was Iceland waiting to happen. The second phase began as the economy’s freefall abated. The then government finally began to act, and was wildly over-lauded.

Things turned again in late summer 2010. Investor confidence drained away and Ireland was the new Greece as it joined the bailout club.

In the fourth, ongoing phase, Ireland is the euro rescue success story, regaining competitiveness and diligently complying with the terms of its bailout.

With each quarter that passes, the real achievements don’t seem to be turning things around. That can continue only so long before an uglier fifth phase begins.