Strong indicators on home front tempered by many risks abroad

ANALYSIS: THESE ARE uncertain times. Predicting the future is unusually difficult

ANALYSIS:THESE ARE uncertain times. Predicting the future is unusually difficult. The range of outcomes for Europe, even in the short term, is very wide. So too for Ireland.

Understanding the present is easier than predicting the future, but not by much. The mix of news on the Irish economy in recent weeks has often appeared contradictory, while most developments internationally have been negative. Where then do we stand now?

Analogy can illuminate. Think of Ireland as a man on a frozen lake. The sound of cracking ice is getting louder. He has made progress towards the shoreline, but efforts up to now will come to nought if the ice gives way and he crashes into the freezing depths. The fear is sickening, but pressing on is the only option.

The thin ice is, of course, extreme financial fragility across Europe. In July the euro crisis moved into end-game territory. Europe’s great collective failure to do more to save itself will have long-lasting consequences of many kinds, but it is the risk near at hand that will have the greatest and most immediate consequence if it comes to pass. A euro zone banking meltdown of unprecedented proportions and a break-up of the currency, once unthinkable, are now real risks.

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Such an outcome is a worst-case scenario, and the scenario, it should be stressed, is a risk, not an inevitability. But that it is a realistic possibility is frightening. That it has not galvanised Europe’s leaders to do more to address the crisis is appalling.

If all this causes fear and despair, many recent developments domestically have appeared almost too good to be true.

Just 10 weeks ago, anyone suggesting that economists would now be jacking up their growth forecasts for the Irish economy in 2011 would have been told to take off their rose-tinted glasses. They would have been dismissed as deluded Panglossians if they had predicted yields on Governments bonds would, in the most extreme case, have fallen by half. Neither outcome seemed remotely likely, yet both have come to pass.

The quite astonishing developments in the market for Irish Government bonds since mid-July have been driven by a turnaround in international sentiment towards Ireland. Up to then, foreigners in increasing numbers had been selling off their holdings of these bonds, and at much below face value, as fears grew that they would not be honoured.

In July, the slide went sharply into reverse. Since then purchasers have outnumbered sellers. If this trend were to continue, the State would be in a position to start weaning itself off subsidised loans from its neighbours much sooner than scheduled under the EU-International Monetary Fund bailout.

A number of reasons explain the turnaround. Big cuts in interest rates on EU bailout funds have eased debt-servicing costs – the turnaround coincided exactly with the July 21st deal in Brussels which cut the interest rates on these loans. This helped move the State away from insolvency.

It also appears as if the world is gradually coming to the view that the March 31st bank rescue measures will provide a sustainable foundation on which to rebuild a much down-sized domestic financial system. The purchase of a stake in Bank of Ireland in mid-summer by high-profile US investors was the most obvious manifestation of that.

A further reason for the partial restoration of faith in the State’s capacity to repay its debts is stronger-than-anticipated economic growth in the first six months of the year. Figures released two weeks ago showed that by the widest measure of economic activity (gross domestic product), the economy grew much more strongly than most other indicators had suggested in the first half of 2011. Tuesday’s decision by the Irish Central Bank to raise its growth forecast for this year was a direct result of these GDP numbers.

These developments are to be welcomed and cannot be dismissed. But they say as much about the uncertainty of our times as they do about any real change in the underlying strengths and weaknesses of the economy. International sentiment towards small economies is notoriously fickle, and Irish GDP numbers are notoriously volatile.

All that said, some more timely indicators of the real economy thus far in the second half of the year give reason to believe the effects of the wider financial crisis have been less negative than they could have been.

Dole queues shortened a little in September after lengthening for four months running. And yesterday’s survey of managers in the services sector, accounting for almost twice as much economic activity as industry and agriculture combined, suggests it grew more strongly in September than a month earlier.

But the signals are mixed and it is not only the euro crisis that gives cause for concern. A manufacturers’ survey on Monday suggested that industry weakened in September, not surprising given most goods made here are for export. With most foreign markets cooling, exports can be expected to provide less of a boost to the wider economy in this half of the year than they did in the first half.

Shoppers spent less in July and August too, according to the most recent retail sales figures. This downward trend is likely to have continued into September – value added tax receipts last month were negative, suggesting consumers didn’t start splashing out.

One of the many reasons for consumer weakness is the huge fall in house prices, which continued in July and August. People’s willingness to spend is lessened when they feel poorer as a result of their major asset becoming less valuable. Nor is the nightmare of over-indebtedness, almost all of which has its origins in property, one from which anyone will suddenly awake. It will remain a drag on the economy well into the future.

If there’s no short- or medium-term fix to that problem, today might just bring relief for debtors, if not savers. The European Central Bank (ECB) is holding its monthly interest rate-setting meeting in the city that appears to be Europe’s de facto capital – Berlin.

The case for cutting rates is very strong, but the chances of that happening are limited. The ECB mistakenly raised interest rates in April and July despite the absence of underlying inflationary pressures and despite the risks of renewed recession. For ECB president Jean-Claude Trichet to cut rates tomorrow would amount to an admission of error. He is just weeks from retirement. It would take a very big man to end his career with such an admission.

But a cut will come sooner or later. Lower interest rates lessen the chances of a return to recession, the avoidance of which is so imperative now – the weaker the real economy, the more difficult it becomes to solve the financial crisis. If it can be solved or even contained then there is no little hope for the Irish economy. If it spins out of control, all bets on everything are off.


Dan O'Brien is Economics Editor of The Irish Times