Sunday 19 January 2020

Conall Mac Coille: No need to raise red flag on fears of rapid mortgage-lending growth

If housing demand exceeds 30,000 units a year, new loans to first-time-buyers should ideally rise substantially above the 17,400 recorded last year File photo: Bloomberg
If housing demand exceeds 30,000 units a year, new loans to first-time-buyers should ideally rise substantially above the 17,400 recorded last year File photo: Bloomberg

Conall Mac Coille

Rapid expansion in mortgage lending shouldn't be seen as a red flag on the Irish economy. The Central Bank of Ireland decided earlier this month to deploy the 'counter-cyclical capital buffer', its new tool, for the first time. Irish banks are now being told to hold more capital to shield themselves against losses in the next downturn.

The Central Bank's decision may reinforce fears that Ireland's economic performance is becoming unsustainable, particularly given pressures in the housing market. Indeed, new Banking Payments Federation Ireland (BPFI) data published shows the mortgage market continues to expand rapidly, with lending up 22pc in the first half of 2018 compared with last year.

However, it is important to remember that on many metrics Ireland's economy does not appear to be overheating. CPI inflation is still close to zero and among the weakest rates in Europe. Similarly, Irish wage growth is running at just 2.4pc, a relatively modest pace, despite the fall in the unemployment rate. During the heady Celtic Tiger era both CPI inflation and wage growth often both exceeded 4pc.

Of course, fears of overheating have been largely driven by the housing market. The new BPFI data last week showed there were €3.7bn of new mortgage loans in the first half of 2018. This is up an enormous 22pc on last year. Is this a red flag that new mortgage lending is expanding too rapidly - creating risks of a fresh housing bubble?

Mortgage lending is picking-up from a very low base. In 2017 there were just over 29,000 mortgage loans for house purchases. This is still the lowest number of new loans given out in any single year since 1987. So current high growth rates in mortgage lending reflect a bounce-back from depressed levels of activity. Most commentators now accept that Irish housing demand will exceed 30,000 units a year, over the next 5-10 years. If so, new loans to first-time-buyers should ideally rise substantially above the 17,400 recorded last year. This should be seen as a welcome development, rather than heralding fresh risks for the Irish economy.

To do so will clearly require the Irish construction sector to build more homes. As homebuilding picks-up towards the 25-30,000 units required per annum - mortgage lending should rise naturally. We are still some way off that target. In 2017, just 14,446 new homes were completed, of which 4,300 were one-off homes more likely to be in rural areas

There can be little doubt though that, left unchecked, Irish house prices could easily move into bubble territory. However, the latest BPFI data is more encouraging on that point. In the three months to June the average mortgage loan for first-time-buyers was €216,000, up 7.7pc from the €201,000 recorded one year ago. This is a substantial increase - but still the slowest pace in two years. In short, Central Bank rules on mortgage lending are starting to work. First-time-buyers are being stopped from taking on ever-higher levels of mortgage debt, at ever greater multiples of their income.

More generally, Ireland's strong economic performance has not been accompanied by rampant lending. In part, this reflects the bubble from the Celtic Tiger years slowly deflating. For example, mortgage lending contracted by 1.7pc in the year to May. However, small-medium enterprises (SMEs) have also been very cautious - so far focusing on repairing their balance sheets, rather than taking on fresh debts to invest in their businesses.

Of course, the Irish economy faces many threats; Brexit, further disruption to world trade from US President Donald Trump's trade policies, or that the lack of housing supply becomes an ever-more difficult bottleneck for the economy.

These risks shouldn't be underplayed. However, the key point is that they haven't been accentuated by aggressive lending in the Irish economy in recent years. Instead, the Central Bank's decision reflects a conservative view to require commercial banks to hold more capital early in the cycle - rather than a clear warning that Ireland's economy is now overheating.

Brexiteers ignoring WTO risks

A depressing feature of the recent turmoil in the UK Conservative party is that hardline Brexiteers are once more putting forward an exit under World Trade Organisation (WTO) rules as a plausible option for the UK to pursue - illustrating the limited influence of experts on the Brexit debate. Head of the Conservative European Research Group Jacob Rees-Mogg has already said this month that the WTO option is 'nothing to be frightened of'. Some have criticised UK Prime Minister Theresa May for not preparing for such an eventuality.

So far much of the debate on the WTO route has focused on the likely tariffs UK exports into the EU might face. On average, these are 4pc for UK manufacturing, a significant competitive loss, but smaller than recent movements in the sterling-euro exchange rate. On that basis some commentators have suggested the economic impact of a WTO type exit might be manageable.

However, this simple analysis ignores additional costs from red-tape and that integrated supply chains would magnify the impact of tariffs - particularly for car manufacturers. Moreover, the legal/regulatory basis for EU/UK trade would be lost overnight - posing the risk of even more disruption, for example by potentially grounding air-travel into the UK.

Of course, it is such a disruptive outcome that it suggests cool heads will ultimately prevail. However, many pro-Brexiteers cling to the fantasy the UK's trade deficit with the EU is a bargaining chip in negotiations. But it is the threat to the UK's entire export trade, not the relatively small deficit, that gives the EU the greater leverage in the negotiations.

UK trade with non-EU countries would also potentially face uncertainty. After Brexit, third countries that had concluded trade agreements with the EU will be under no legal obligation to carry over past commitments for the UK.

Indeed, just this week the EU and UK began the formal process of splitting their membership of the WTO, with several members including the United States, Canada and Australia expressed their disapproval of the divorce terms. WTO members now have three months to review the terms of the divorce.

Unfortunately, past predictions that the UK might enter recession following the 2016 referendum are now being used to undermine serious analysis of the WTO route. However, the evidence is building that Brexit is already having a slow-burn drag on the UK's economic performance. The latest Deloitte survey of UK Chief Financial Officers (CFOs) found that three-quarters expect Brexit to lead to a deterioration in the business environment in the long-term.

According to the survey increasing cash flow and cutting costs now the top priorities for UK CFOs. Moreover, the spring 2018 Deloitte survey found the UK was the only country across Europe where CFOs were planning to cut back on capital expenditure - and are even more uncertain on the economic outlook than their counterparts in Greece.

Of course, Brexit hasn't happened yet. A disorderly no-deal outcome could quite likely trigger one of the many imbalances in the UK economy. Any shock to consumer confidence, already dependent on cheap credit and low household savings, could lead to a sharp pull-back in consumer spending. No doubt sterling would depreciate sharply - pushing CPI inflation back above 3pc and squeezing households' real incomes.

Finally, UK house prices are already fragile, with affordability and the mortgage market stretched. A no-deal Brexit would almost certainly push UK house price inflation into negative territory.

Conall MacCoille is chief economist at Davy

Sunday Indo Business

Also in Business