PROSPECT OF NO BUDGET BOANZA IS GOOD NEWS

This Article appeared in the Irish Examiner June 22nd 2018

Despite what some media commentators have suggested about the lack of detail contained therein, the Summer Economic Statement released by the Department of Finance is not meant to be a detailed breakdown of what the Minister for Finance will deliver on the fiscal front. The statement merely sets out the economic and fiscal parameters that will guide budgetary policy in 2019. We will have to wait for the budget in October to get the detail of what is planned.
This week’s statement does give us a very good overview of what will guide budgetary policy in 2019 and thereafter. The Government plans to reduce the budget deficit to just 0.1 per cent of GDP in 2019, which will be consistent with a budget day package of a not insignificant €3.4 billion. However, of this total, €2.6 billion is already pre-committed in the shape of €1.5 billion in extra capital spending through the National Development Plan; €300 million will be used up by the carryover effects of the measures introduced in Budget 2018; €400 million will be absorbed by public sector pay increases already committed to; and €400 million will be absorbed by extra spending on the back of demographic developments. This will leave €800 million to be given away on budget day through a combination of tax changes and expenditure increases. It is clear that if any significant tax alleviation measures are introduced, they will most likely have to be largely made up through tax increases elsewhere, for example on the ‘old reliables’.
The bottom line is that Ireland’s public finances are continuing to improve, but the fiscal situation is still challenging and Ireland is still and will remain constrained by EU fiscal rules. So, anybody awaiting a budget bonanza in October will be sorely disappointed. That is just as well because the last thing in the world the economy needs at this juncture is an expansionary fiscal package on top of what is already pencilled in. The Minister stated that the rules would allow him give away an extra €900 million away on budget day, but he is not going to do that. This is a relatively prudent and sensible strategy, and we should hope that the machinations of the current political setup will not force any changes to this approach.
The strategy outlined this week is obviously totally and utterly dependent on the performance of the economy. The level of growth is the most important driver of tax revenue and expenditure and if this were to disappoint, then the strategy would have to change. Of course, we all should recognise the futility of economic forecasting, particularly for a small open economy that is so exposed to the vagaries of global developments. This week’s budgetary strategy is predicated on GDP growth of 4 per cent in 2019; 3.4 per cent in 2020; and 2.8 per cent in 2021. Based on what we currently know and understand about the economy, these growth projections look quite realistic, and possibly a little bit conservative. The Department has identified Brexit, the risk of a global trade war and rising interest rates as the main external threats. The main domestic threat is that of overheating. Hard to argue with that.
The Minister is also going to plough ahead with the ‘Rainy Day’ fund which will see €1.5 billion put in from the Ireland Strategic Investment Fund (this is where some of the proceeds of the lost and lamented National Pension Reserve Fund ended up); and €500 million per year will be put in between 2019 and 2021, taking the fund up to €3 billion. This is a relatively small amount of money in the overall context, but at least it is a step in the right direction. There is a risk that the existence of such a fund could give rise to ‘moral hazard’, whereby less prudent policies might be pursued safe in the knowledge that the ‘rainy day’ fund would be available should things go awry.
Interestingly, the Minister intends to set aside historically high levels of corporate tax receipts for the fund. It remains to be seen how this will work, but it is a sensible strategy not to spend on the back of potentially transitory tax receipts. Pity we did not pursue such a strategy from 2000 onwards.
I have heard some criticism of the fund on the basis that the money would be better spent on capital projects that would improve the long-term growth potential of the economy. This makes sense in theory, but in practice there is now limited capacity in the economy to deliver capital projects.

THE DANGERS OF BEING THE BEARER OF GOOD NEWS

This Article appeared in the Irish Examiner June 15th 2018

Last week I wrote a pretty upbeat piece on the Irish economy, with a strong focus on ongoing positive trends in two key components of the indigenous economy, namely Tourism and the Agri-Food sectors. Predictably, I got a negative response from certain quarters, with one in particular claiming that it read like ‘a PR piece to encourage inward investment and that as usual there is a certain group in society doing well and feeling positive, but far too many are being left behind again’.
Difficult to know how to respond to that accusation without coming across as callous and cruel. A point to note is that I did not once mention inward investment and my focus was very much on the domestic side of the economy and on the growth that is being experienced in some key domestic components. This is difficult to argue with.
It is a fact that the reality of life in every developed country in the world is that some people will do better than others, due to factors such as educational attainment, social background, the quality of employment, and the willingness to work hard and take risks. Those with higher levels of educational attainment generally tend to get higher quality and better paid jobs, which in turn is often heavily influenced by social background. It is also generally the case that the harder one is willing to work and the more risks one is prepared to take, the better off one will be. I use the term generally, as it is obvious that this is not always the case.
The challenge for policy makers is to ensure that those who do not get the best opportunities to improve themselves, who are unable to work, or who suffer from some other disadvantage are helped to the greatest extent possible. Ireland does this quite well. The country has a very progressive tax system, in the sense that the more one earns, the more one pays in tax. The proceeds of taxation payments are then used to fund a pretty generous and progressive social protection system, and also to fund public services. People can moan forever about the nature of our economy and our society, but the truth is that if we do not have economic growth and if we do not have people in society doing well, the resources to fund social expenditure and public services will not be generated.
I did not and would not argue for one moment that Ireland does not still have many problems, it does. The lack of sufficient housing and under-funded health, education, and law and order immediately spring to mind. It is a fact that having experienced the most significant economic shock in generations back in 2007, there are still significant legacy issues to be addressed, but at least with the strong momentum in the economy, we will be given the opportunity to address those issues. Without growth, very little would be possible.
Thankfully, as I pointed out last week, we are seeing a lot of growth coming through and the latest data releases show clearly that the good news is continuing to pour forth.
This week, the Industrial Development Authority (IDA) suggested that it is having a very strong first half and that the investments already approved so far this year will lead to the creation of over 11,300 jobs, which is marginally ahead of the first half of last year. The IDA is continuing to attract strong overseas interest in its investment proposition, and that is unambiguously good news. Of course, there are challenges and risks involved here, but that is the nature of economic and business life. Managing the risks in a prudent manner is key.
It is not correct to suggest that a rising tide will lift all boats, but a rising tide is still preferable to a falling one. I firmly believe that the best thing that is currently happening in the economy relates to labour market developments. The level of unemployment declined by 15,600 in the 12-month period to May and the unemployment rate has fallen to 5.8 per cent of the labour force. Since the low point of the labour market in January 2012, the number of people unemployed has declined by 217,300 from 356,300 to 139,000. Of course, we can argue with the quality of some of the employment being created, but the trend should be welcomed by any sensible person with an open mind.

INTEREST RATE TRENDS

THIS BLOG FIRST APPEARED AS A BLOG FOR FRIENDS FIRST JUNE 15th 2018

The process of interest rate normalisation continues apace in the United States. On Wednesday night the US Federal Reserve Bank increased interest rates by 0.25%, taking the target range for the key Federal Funds Rate to 1.75% to 2%. This rate has been taken up from zero in December 2015.
The Federal Reserve move this week came as no surprise but the forward guidance issued by the interest rate setting body, the Federal Open Market Committee (FOMC,) was perhaps slightly more aggressive than might have been expected. It is important to remember that the mandate of the central bank is to foster maximum employment and price stability. Price stability is defined as a rate of around 2%.
In the statement accompanying the latest rate move, the FOMC justified the latest increase on the basis that the labour market has continued to strengthen and economic activity has been rising at a solid rate. Indeed, in May the unemployment rate fell to 3.8% of the labour force and the economy created a strong 218,000 jobs during the month. The Committee also pointed out that recent data suggest that household spending is strengthening and business fixed investment has continued to grow strongly. At the same time inflation on key measures has moved close to 2%.
The Federal reserve is achieving its mandate and indicated this week that it expects to deliver further gradual increases in its key interest rates over the coming months. It is certainly possible that another 1% will be added to rates over the coming year.
This interest rate trend is purely and simply a move away from an emergency interest rate situation that was put in place to deal with an exceptional economic crisis and now that that crisis has abated and gone away, we are moving back towards a more normal interest rate environment.
The markets are continuing to take the normalisation on interest rates in their stride. The 10-year bond yield is currently trading at 2.96%, which is pretty much where it has been trading in recent months. One would expect bond yields to gradually rise from here over the coming months. On the equity market front, US markets barely reacted to the latest interest rate increase and in the year to date, the Dow Jones is up by 1.95% and the S&P 500 is up by 3.82%. While these gains may look modest, it does represent a very impressive performance in the context of the various challenges encountered by markets in recent months. The large tech stocks are the key drivers of the strong equity market performance, which does represent a reason for some caution.
In Europe, the situation stands out in contrast to the US. The process of interest rate normalisation has not yet started and the European Central Bank (ECB) is not in any hurry to do so.
The ECB has an official inflation target of 2% or slightly lower. The inflation rate has been consistently well below 2% for a prolonged period of time, but in May jumped to 1.9% from 1.2% in April. On the surface this does look worrying, but the surge is largely due to energy costs. In the year to May, energy costs increased by 6.1%, reflecting what is happening crude oil prices. Brent Crude is currently trading at $76.36, which is the highest level seen since late 2014. At one level this increase in oil prices would be seen to damage economic growth in the Euro Zone, but from the perspective of central bankers, the fear is that higher oil prices would start to feed into wage pressures as workers seek to offset the negative impact of oil prices on their cost of living. The ECB will watch these second-round impacts of higher oil prices very carefully over the coming months.
The growth backdrop in the Euro Zone has undoubtedly softened so far in 2019. In the first three months of the year, GDP expanded by just 0.4% during the quarter and the annual rate softened to 2.5% from 2.8% the previous quarter. This is still a decent level of growth, but most economic indicators are suggesting a modest softening in growth. The recent strength of the euro will help allay any nervousness the ECB might be feeling at the moment.
This week the ECB left its key interest rate unchanged at zero and it remains relatively relaxed. However, it did suggest that the monthly bond buying programme (Quantitative Easing) will remain at its monthly rate of €30 billion until the end of September, and this will then be reduced to €15 billion per month and will then end. In relation to official interest rates, the ECB currently believes that rates will remain at current levels at least through to Summer 2019.
This prognosis is all predicated on growth continuing at current levels and inflation gradually converging towards 2%. Of course, circumstances can change, but for the moment the ECB is quite relaxed about the world it governs.
Tracker mortgage holders and other Irish borrowers can remain relaxed for the moment but should also recognise that this nirvana will eventually end. The question is when? The answer is not yet.

OPTIMISM OVER ECONOMY IS VERY REAL AND VERY POSITIVE

This article first appeared in Irish Examiner 8th June 2018

In the midst of some signs of an easing of Eurozone growth so far in 2018, it is interesting to observe that almost all data releases are providing a very upbeat assessment of what is happening in the Irish economy.

In the midst of the economic crisis some years back, there were many prepared to argue that the Irish economy would not emerge from the morass in a generation and, indeed, a number of commentators made a strong media name for themselves by preaching an incredibly negative narrative about Ireland’s prospects.

I never accepted this narrative as I always believed that it is not the nature of the Irish to sit back and accept the apparently inevitable.

However, I have been taken somewhat aback at the speed and magnitude of the economic recovery.

Ireland has certainly defied the conventional view in a very positive manner. It says a lot about the Irish mentality and about the spirit of entrepreneurship that permeates the national psyche. Long may it continue.

In the midst of the crisis, policymakers took some very difficult fiscal policy decisions and a lot of pain was felt by a lot of people.

This obviously helped put the public finances back on track and helped restore international confidence in the economy much more quickly than anybody would have anticipated.

However, I think most importantly, some strong and sensible strategic decisions were taken to ensure that the two most important indigenous sectors — tourism and agri-food — would provide the pathway for the emergence of the economy from a very difficult place.

Indeed, that has turned out to be the case and both sectors have played a key role in driving the economy forward.

In 2017 for example, 9.93 million overseas visitors came to Ireland, which was the highest level in our history.

Data released by the CSO last week showed that the strong tourism performance has continued into this year.

In the first four months of the year, 2.82m overseas visitors came into the country, which is 7.3% ahead of the same period in 2017.

Visitor numbers from Britain are up 1.5% and accounted for 39.7% of total overseas visitor numbers.

The North American market expanded by 13.6%, and visitor numbers from the Rest of Europe increased by 12.3%.

These are incredibly impressive visitor numbers and certainly suggest that just as Bord Bia is doing a superb job promoting the Irish agri-food sector, Tourism Ireland and Fáilte Ireland are doing a superb job promoting Irish tourism.

The recent relative strength of sterling is good news for Ireland, but the more recent strengthening of the dollar is particularly good news.

When the dollar was sliding significantly during 2017, fears about the impact this currency move might have on the attractiveness of the Irish market for US visitors were justified.

On the agri-food side, the uncertainty presented by Brexit is obviously of key concern, but it is good to see that Irish policymakers are taking a very proactive approach to developing new more exotic markets like China and South Korea. The sector is still doing very well.

The great thing about the contribution of tourism and the agri-food sector is that they both have a strong regional and rural footprint, and both have a strong domestic value-added content.

In other words, the inputs into both sectors are very much domestic, both are labour intensive and leakages are not significant.

All in all, Ireland now finds itself in a very strong place and the sense of optimism and enthusiasm is very real and very positive.

Regardless of one’s views on the recent referendum, the sense of enthusiasm and optimism it has generated amongst young people, in particular, is a joy to behold.

Socially, Ireland is now becoming a very progressive and outward looking country and this just serves to feed into the very positive trends on the economic front.

It is good to be Irish at the moment and it would be nice to see an optimistic narrative swamping the negative narrative that has been so prevalent over the past decade.

Ireland is moving forward, and long may it continue.

ITALY’S HUGE DEBT PUZZLE

This article appeared in Irish Examiner 1st June 2018

Following the momentous global political dislocation in 2016 that resulted in the election of Donald Trump and the UK vote to leave the EU, there was a lot of concern about the European political calendar coming into 2017.

Elections were upcoming in the Netherlands, France, and Germany, and the fear was that the anti-establishment trend could be replicated in those countries, with negative implications for the future stability of the eurozone.

Notwithstanding some weakening of Angela Merkel’s position in Germany, all three elections basically turned out reasonably good.

On top of this, the eurozone growth performance in 2017 turned out to be relatively stellar and suddenly all of the long-term doubts about the stability of the monetary union faded into distant memory.

However, over the past few weeks we have come back down to earth with a bang.

Coming into 2018, the markets and the rest of us knew there was going to be an election in Italy in March and we knew that the anti- establishment parties were performing pretty strongly in the opinion polls.

Although we all knew this, we weren’t terribly worried and the typical reaction in the markets was a shrug of the shoulders, an attitude of ‘what else would you expect from Italy?’ and a view that, as always, Italy would muddle through, as would the rest of us.

Over the past week, the Italian situation is threatening to turn into another outright crisis for the eurozone. Italy is a significant player in the eurozone and is the third largest economy.

However, its growth performance over the past couple of decades has been abysmal. It currently has an unemployment rate of 11% and at the end of 2017, its government debt-to-GDP ratio stood at 131.8%, which compares to around 68% in Ireland, and a eurozone average of 86.7%.

The European Commission has been extremely concerned about Italy for some time. Not surprisingly, the euro has come under considerable pressure, Italian bond yields have gone up, and equity markets have been given another reason to become nervous and volatile.

One positive is that the latest bout of uncertainty will just serve to postpone further the change in interest rate policy from the ECB and the weaker euro will help Irish exporters.