High dependence on the property sector poses a significant risk to the current strength of the economy, the Central Bank warned yesterday. The bank has revised its forecast for economic growth in 2006 upward slightly to 5 per cent and said the growth would be more balanced than last year, with more growth in exports and productivity and less reliance on employment growth, writes Laura Slattery.
The bank predicts a similar strong performance in 2007, but has cautioned in its latest quarterly bulletin that the construction boom currently driving the economy will not last and that re-accelerating house prices were driving consumer borrowing at a rate that is unsustainable.
House price inflation has accelerated since last autumn from rates of 6 to 7 per cent to over 11 per cent, which the Central Bank described as a "worrying development" that increased the risk of a sharp correction in the market.
The house price increases coincided with the easing of credit conditions by mortgage lenders and partly reflected increased efforts to market 100 per cent mortgages, the bank said. It said it has launched a new round of stress tests of financial institutions in order to assess their vulnerability to economic shocks, such as jumps in interest rates and mortgage defaults.
The results will be shared with the financial regulator and published in the Central Bank's financial stability report later this year.
The year-on-year increase in mortgage lending was almost 30 per cent in the first twomonths of 2006. Mortgage borrowing accounts for more than three-quarters of personal sector borrowing. By the end of 2005, the ratio of personal debt to disposable income had increased to 132 per cent, up from 115 per cent at the end of 2004.
The Central Bank said lenders and borrowers needed to be aware that this situation could not continue indefinitely. Tom O'Connell, the Central Bank's assistant director general, said he did not think any country in the euro zone would be happy with rises of over 30 per cent in personal debt.
Mr O'Connell also cautioned that the current level of activity in the construction sector, where there were 81,000 house completions last year, was beyond what was required over the medium-term and that there would eventually be a contraction to about 60,000 new units per annum. "This could present adjustment problems if the contraction were to be quite rapid."
A downsizing in the construction sector would both reduce employment growth and cut tax revenues, the Central Bank noted. The construction sector accounted for almost a third of the increase in total employment in 2005.
An increase in employment of 87,000, or 4.7 per cent, accounted for almost all of economic growth last year, when there was a 5.4 per cent increase in gross national product (the value of the goods and services produced by the economy less the contribution from multinationals) and a 4.7 per cent growth in gross domestic product (the value of the goods and services produced by the economy).
The concentration of employment growth in sectors where productivity increases are traditionally low meant that real pay increases rose faster than productivity. Labour costs increased by 4.5 per cent last year, compared to an average increase of 1 per cent in the euro area.
Despite the cost pressures, the manufacturing sector has recently begun to see increases in output. However, the Central Bank said it was important that future pay developments protect competitiveness in light of earlier losses and higher globalisation pressures.
While the projected general Government deficit of 0.6 per cent of GDP was small, the Central Bank said it would prefer to see the Government run a small surplus to provide for unforeseen events.