Sunday 20 October 2019

Economy is still driving on - but Brexit has applied brakes

Goods exports in January surged yet again to hit another all-time monthly record
Goods exports in January surged yet again to hit another all-time monthly record
Dan O'Brien

Dan O'Brien

The past week saw a slew of data published on the Irish economy. The figures, when taken in the round, show an economy that is still growing. But an increasing number of indicators are pointing to a slowdown. The dreaded Brexit, and the uncertainty it has generated, is at the root of the weakening.

Among the indicators published was the GDP figures for the final three months of last year. In most countries this is the most important indicator of overall economic performance. But, as is well known, Ireland's GDP figures are distorted by the extreme openness of the economy. They always need to be treated with a lot of caution.

As such, let's first consider what can be relied upon in the GDP data to tell us something meaningful. First and foremost is consumer spending. Purchases of goods and services by consumers account for the biggest chunk of expenditure in the domestic economy.

The figures showed that 'private consumption', as its known in the GDP jargon, rose by 0.5pc in the final quarter of 2018 compared to the third quarter. That represented a marked slowdown on the middle of the year. More recent monthly figures for retail spending, a much narrower measure of consumer expenditure, show that there was a further weakening in the early months of 2018.

What accounts for this? It is certainly not because people have less money. Wage growth is surging. A tightening labour market has pushed unemployment down and given workers more bargaining power on pay.

Some of the slowdown in overall consumer spending growth is likely explained by a slowdown in the rate of employment growth. The numbers at work in the economy continue to grow, but at a decelerating rate.

However, stronger pay growth and slower employment growth should be balancing each other out in terms of the change in overall consumer income. If that is the case, then the slowdown in consumer spending is more likely to be explained by precautionary saving.

Growing concerns over the effects of Brexit are the most obvious reason for this.

The KBC/ESRI consumer sentiment index weakened over the course of 2018. By the final quarter of last year consumers' future expectations hit their lowest level in almost half a decade. In February, that measure nose-dived. The monthly fall of 17 points was bigger than anything recorded during the years of banking crisis and bailout. Even if a no-deal Brexit can be avoided at the end of next week, it has already had a negative effect on the most important part of Ireland's domestic economy.

Much better news came from the export side of the economy. Friday brought the first trade data of the new year. Goods exports in January surged yet again to hit another all-time monthly record. In January more than €13bn worth of stuff was shipped overseas, close to a doubling on five years ago.

Thursday's balance of payments figures give the only timely data on the other side of the export picture - internationally traded services. Their growth in recent years has been even more phenomenal than manufactured goods. In the final quarter of last year they surged to fresh records highs, yet again, reaching almost €50bn.

If there is any less-than-positive aspect to these developments it is that goods and services exports are becoming more concentrated on individual sectors. Pharmaceuticals and chemicals account for more goods exports than all others combined, including food.

Computer services are becoming similarly dominant on the services side. This may be an inevitable result of the specialisation process small economies tend towards, but it does increase vulnerability to sector-specific shocks.

Last week also saw fresh data to shed light on the hyper-topical issue of housing. The CSO published planning permission numbers for final quarter of last year and its house price figures for January. Planning permissions are a decent indicator of future supply. As the dogs in the street know, the supply of new homes is well below demand. The result has been higher house prices, soaring rents and more homelessness.

Friday's planning permission numbers showed a massive 40pc increase in new home planning permissions in 2018 compared to 2017. That is very good news in terms of the supply pipeline and comes on top of a strong trend in recent years, which has seen a very strong increase in home-building, albeit from a very low base. Less good was the trend over the course of year, which, if continued in 2019, would suggest much less of increase in planning permissions this year.

The ramping up of supply in recent years, as the residential side of the construction industry recovers and higher prices boost builders' profits, has contributed to a cooling house price inflation. Indeed, national house prices fell, month-on-month, in November, December and January. That was the first time since the economy recovered that prices have fallen for three months on the trot.

It would be wrong to overstate the importance of this development. The housing market always slows around year-end and underlying demand and supply factors mean that prices are more likely to rise than to fall in the short term. But things have certainly cooled a little, in part because of an increase in supply. That is also to be seen in rents. Last week's consumer price data showed that overall inflation remains almost non-existent.

The private rents component was, as it has been for years, far ahead of the overall rate of inflation. In February it dipped below 6pc year-on-year. That is far ahead of wage growth and explains why so many renters are having a tough time. But solace may be found in the fact that rent inflation is well off the peaks of a couple of years ago.

So, bringing it all together: the past week's data shows that the economy is doing well, but that Brexit effect is having something of a chilling effect. If it is postponed for a significant period, there is every likelihood of a strong bounce-back in the second quarter. If it is merely postponed until the second quarter, expect a further cooling. If no deal happens at the end of next week, put on your tin hat.

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