Solid performance likely but no fireworks

Economics: Economy shows 'cappuccino' extremes of activity - booming house prices and manufacturing lay-offs, writes Cliff Taylor

Are we living in a "cappuccino economy"? All froth on top but flat underneath. In the property market rapid house price growth and booming borrowing, in the manufacturing sector competitive pressures and lay-offs.

The contrast between the two extremes of the economy is striking. At one end is the housing market, with prices currently growing at an annual rate of 13 per cent and borrowing up an astonishing 26 per cent. At the other stands the manufacturing sector, with the latest figures showing an annual drop of 7,600 drop in job numbers and production and export figures pointing to a difficult environment.

Not surprisingly, in the run-up to the pay talks due to get under way in earnest after Easter, the trade unions are pointing at the positive indicators and the employers are accentuating the negative. In the middle the economists state solemnly that growth will be in the 3 to 4 per cent range this year (always a good figure to go for when you're not sure how things will work out !)

Let's get a few things straight first. The economy has proved remarkably resilient over the past couple of years. Gross national product growth of 3.3 per cent last year was a solid performance in a difficult international environment. A 44,600 increase in the total number of people at work is even more remarkable.

What is in question is the extent of the economic recovery and its spread across the economy. The GNP figures for the end of last year suggest that recovery is reasonably broadly based. However, since the period covered by these figures two trends are particularly evident. First, the international recovery has appeared to falter, with obvious implications for exporters and for confidence levels. There is particular doubt about the outlook for the euro zone.

The US recovery had also looked a bit lacklustre, until last Friday's jobs figures showed an enormous 300,000 increase in employment. If this continues then the US recovery will be underpinned by rising consumer activity and should be sustainable. This will benefit the euro zone to some extent, but the big German and French economies have appeared to reverse over the past couple of months.

So the outlook for the exporting sector is improving, but slowly. And clearly the competitiveness losses of the last few years are having an impact.

The second trend, at the other end of the economic spectrum, is the never-ending boom in the housing market. Housing prices - and mortgage borrowing - have been rising at multiples of the economic growth rate. A record 69,000 houses were built last year and still demand in the market appears to be greatly outstripping supply.

The beneficiaries of the boom include auctioneers, builders, mortgage lenders, land owners and those lucky enough to make property investments.

But is the wealth created in the main part of the economy enough to sustain the exuberance of the frothy bit? Not in the long term, obviously. If we keep borrowing an extra €1 billion a month - the recent average - then sooner or later a lot of people will run into repayment problems.

Recent work by the Central Bank and the ESRI suggests that the debt levels here are, on average, not yet excessive by international standards, or judged by the likely ability to repay. And clearly there is no obvious " risk" in the short term to borrowers - interest rates look set to remain low and could even edge down slightly further and there is no reason to expect unemployment to climb in the months ahead.

However the frothier the top of the economy becomes, the more vulnerable it is to any further economic shocks. And the risk is now that just the plain old interest rate cycle, when it starts to turn up eventually, could land some newer borrowers in trouble, particularly those dabbling in the higher end of the investment market. It may all work out swimmingly, of course, with prices gradually moderating, interest rates remaining relatively low, rising economic growth taking some of the strain and the market heading for the much-talked off " soft landing." But the longer the housing and borrowing boom goes on, the riskier it will get.

Perhaps the most interesting question is the health of the bit of the economy between the frothy top and the under-pressure manufacturing exporters. Manufacturing is traditionally seen, with some justification, as the engine of wealth. But services are the biggest part of the economy and key wealth creators in their own right.

Due to its diversity - anything from a public sector hospital to a private sector software firm - it can be hard to get a fix on "services" and is a mistake to generalise too much.

However, broadly services is clearly doing better than manufacturing, with a 44,000 rise in services employment in 2003 compared to a 7,600 fall in manufacturing. Increasing manufacturing output - driven by rising productivity - means this sector is still generating increased wealth for the economy as a whole and remains a key plank for the future. However the services sector is where the bulk of people earn their living and its share of national output - and economic "value added" - can only continue to rise.

The regular flow of figures from the housing market and from manufacturing gives us the "cappuccino" extremes of economic activity. Perhaps we should be looking a bit more at the huge growth in services activity, not only those providing ever more exotic types of coffee on our streets, but also the enormous growth of activity in areas like business and financial services - much of it now serving international markets.

On this measure the "real" state of the economy is probably somewhere in between the two extremes. Perhaps a bit worrying, the recent NCB index of purchasing managers in the services sector shows that while it is still expanding, the rate of growth continues to slow. A solid year seems in prospect for our economy, but - apart from the housing market - not a spectacular one. More a solid mug of regular coffee than a frothy fix, really.