Saturday 7 December 2019

Caution, not confidence is key feature of the recovery

Austin Hughes Chief Economist for KBC Bank Ireland

Austin Hughes

LAST year was the year we said a proper goodbye to the downturn in Ireland. What precisely might replace the pain remains unclear. There is a strong sense that conditions should be notably better than those experienced since 2008 -a not particularly demanding expectation. Equally, there is widespread scepticism that we might return to the boom, a possibility hinted at both in the strength of recent economic releases and the scale of largesse emerging in political promises.

On some measures, it might seem the boom is already back. Current estimates put GDP growth at around 7pc in 2015 which would be the strongest performance since 2000. With car sales surging, unemployment tumbling and worries about a shortage of housing, there are clear echoes of earlier times.

Confidence surveys appear to send a similar message. The KBC/ESRI consumer sentiment index posted a new ten-year high in December while business sentiment, as measured by the index KBC developed with Chartered Accountants Ireland, reached its strongest level in over nine years.

Firms and households both seem to be signalling that things are clearly improving. However, the details of these surveys suggest the future looks quite different to the past. They suggest caution rather than confidence is the key feature of the upswing.

For the majority of Irish-based firms, the business sentiment survey suggests 2016 is starting on a very positive note. Almost two-thirds (65pc) say their activity levels increased in the past three months compared to just 6pc that reported weaker trading conditions. This suggests a very broadly based upswing is under way and is expected to continue in coming months.

Significantly, the survey suggests companies are adjusting their output and staffing levels in response to, rather than in anticipation of, improving demand. Usually, at this stage of the cycle, growing 'animal spirits' would prompt firms to scale up production and add aggressively to their payrolls. Instead, it seems the painful experience of recent years, coupled with a quite uncertain global backdrop, is producing an altogether more cautious approach.

This caution is deeply entrenched. While more Irish businesses began to report increases rather than declines in their own output as far back as late 2012, it wasn't until late 2014 that they began to signal optimism about the broader Irish economy.

This implies that uncertainty rather than ambition has been the key influence when deciding how much to produce and how many to hire. In turn, this means the Irish economic upswing has been a story of companies catching up with rather than anticipating improving demand.

For Irish consumers, the recovery in confidence has been a very different process. For a considerable time, consumers were reading about an improving Irish economy that seemed entirely removed from a continuing deterioration in their personal finances. This stark divergence, between the blossoming Irish recovery of media reports and the financial strains consumers were experiencing, did not make for happy households.

Importantly, through the past year, a sense that Irish consumers might be beginning to share in the economic upturn began to build.

More recently, the end of major austerity measures and two Budgets that supported rather than shrunk spending power seem to mark a turning point. December's ten-year high clearly indicates confidence is returning. Equally, with many still facing challenging conditions, this result emphasises just how difficult most of those ten years were for the average Irish household. Even now, slightly more consumers think their financial situation worsened than believe it improved in the past year.

The December survey shows 33pc of consumers anticipate better spending power in 2016 but as many as 16pc expect their household finances to worsen in the year ahead. Among that significant latter group are those facing a range of difficulties encompassing unemployment, low incomes and high debt. More generally, responses to this question suggest that two-thirds of Irish consumers do not think their personal finances will improve in the next 12 months.

This is still a striking disconnect between reports of a booming Irish economy and the economic realities facing most Irish families.

'Feel-bad' may have faded but the 'feel-good' factor is still scarce. In these circumstances, it is scarcely surprising that promises of lower taxes and higher social spending seem so seductive.

While there are pockets of strength and regular media reports of a return to 'conspicuous consumption', there is little sense that, in aggregate, Irish consumer sentiment or spending are now approaching anything like a 'Tiger' trajectory. The painful experience of recent years has left many, possibly most households scarred and cash strapped. This is seared into their attitudes and their actions.

While increased employment and pent-up demand for cars, household goods and even clothing may be boosting purchases of late, recent retail sales data highlight how hard shops work for every euro. The volume of spending in November may have been about 10pc higher than the last boom year of 2007, but the amount of cash that Irish consumers spent was some 16pc lower, reflecting the scale and spread of price discounting.

Irish consumer and business sentiment measures now signal a widespread sense that the worst is over and economic recovery has taken hold.

Companies are notably more confident about their own financial circumstances than are households. To a significant extent, this reflects the nature of a recovery that was led by external demand for business output while consumer spending power was curbed by a sharp and substantial domestic adjustment.

In addition, the business sentiment survey reflects only those companies that survived whereas consumer sentiment reflects the spectrum of household circumstances.

Significantly, both surveys emphasise the recovery is being earned rather than enjoyed at present.

That is understandable. The traumatic nature of the recent downturn is likely to make companies and consumers more concerned about the risks of being too optimistic rather than too cautious in their behaviour.

It is said that it took a generation to shake off the memory of the Great Depression in the US.

Will promises of fiscal largesse erase such concerns in Ireland - or could they make households and businesses even more cautious? We will learn a lot about the lessons and the legacy of the downturn in coming months.

Austin Hughes is chief economist with KBC Bank Ireland

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