Potential risks to economy outlined in financial review

THE IRISH economy faces a number of serious risks, according to a report published by the Central Bank.

The Macro-Financial Review, published for the first time yesterday, said the economy was “fragile” and “some macro indicators are not performing as well as envisaged”.

Recent external developments have made the situation more difficult by increasing uncertainty, the analysis found.

Although the report focused on the chances of negative events occurring, it also said there was a possibility of the economic and financial performance turning out better than currently expected.

On the risk of the State defaulting on its debts, the report noted the fall in interest rates on Government debt in recent months. This has lowered the risk of default.

The report attributes the improvement in part to a reduction in interest rates on the State’s bailout funds, moderate economic growth and the implementation of budgetary adjustments as planned. But the recent improvement in investor sentiment could go into reverse. The report said that “financial market participants’ views of Irish debt sustainability can change quickly”.

It also said that a range of domestic and international developments could increase the probability of default. These include lower economic growth at home and abroad, sovereign default elsewhere and inadequate euro area bailout funding.

Of the most serious risks to financial stability – including sovereign default – is yet more losses in the banking system owing to exposure to falling property prices.

An acceleration of the rate of decline of residential property prices in 2011 was greater than the Central Bank anticipated in its stress tests of the banks, conducted in the months after the EU-International Monetary Fund bailout at the end of 2010.

The central scenario set out in the test a year ago foresaw a year-on-year decline in home prices of 13 per cent up to December last year. In the event, prices fell by almost 17 per cent, only fractionally less than its worst-case scenario.

The lack of mortgage finance is compounding problems in the property market, finds the report. The numbers of new mortgages being issued is almost one-tenth of the numbers issued in 2005-2006.

A recent slowdown in the rate at which commercial property prices are falling may be attributable to the ending of legislative uncertainty regarding upward-only rent reviews, the report suggested.

Under the stress test baseline scenario, commercial property prices had been expected to fall by just 2.5 per cent last year. The decline turned out to be considerably larger, at 12.4 per cent. This, however, remains substantially less than the worst-case scenario, which had envisaged a decline of 22 per cent.

If property prices fall below the worst-case scenarios, there is a risk the banks will need even more additional capital than already injected into them. The bank said it published the report to “help decision makers in the financial sector correctly evaluate risks”.