Friday 19 January 2018

The great post-crash recovery may now be fizzling out

Can a government led by a Taoiseach desperate to stay in office hold the line on spending?
Can a government led by a Taoiseach desperate to stay in office hold the line on spending?
Richard Curran

Richard Curran

The Irish economy is rapidly losing momentum. A plethora of economic and financial data on both sides of the Irish Sea this week shows just how tricky things may yet become. The scale and pace of our economic turnaround in Ireland after the crash surprised everyone. Unemployment fell more sharply than many imagined. House prices began to recover sooner. Irish GDP shot up to 5pc to 7pc per year, despite the fact the country was carrying the second largest debt burden per head of population in the world.

The reality behind the turnaround is that we had three favourable tail winds - a cheap euro, cheap oil prices and low interest rates.

The euro isn't looking quite so cheap against sterling now. The British currency has swung around by just over 20pc in the last year, undermining the competitiveness and profitability of Irish exporting companies. And the worst has yet to come as the Bank of England cut interest rates during the week.

Exchequer figures during the week showed that while the overall tax take is around €644m ahead of target so far this year, Vat receipts are €292m behind. In fact they were €61m behind projections for the month of August alone.

Too much of the improvement in the Exchequer figures has been built on Corporation Tax take. The jury is still out as to whether this represents a long-term sustainable platform of tax revenue, or a flash in the pan based on how a handful of corporations have responded to changes in taxation in the global environment.

We have also been taking in lots of money in things like VRT on the back of buoyant car sales. Many of these car purchases are based on turbo-charged borrowing packages known as Personal Contract Plans, which may yet go badly wrong for many people.

On the jobs front, while the economy has continued to deliver on job creation in the first three months of this year, the unemployment rate remained unchanged at 7.8pc in the month of July. The danger here is that unemployment levels may be plateauing or about to get stuck at current levels.

Consumer sentiment fell sharply in July too, according to the latest index published during the week. Commentators said the fall was not as much as expected given the outcome of the Brexit referendum. But we don't know the basis on which they built their expectations. They might have plucked a figure out of the air and then said the good news is it hasn't fallen as much as we expected.

And the storm clouds are really gathering in the UK. Consumer sentiment there fell by its biggest amount since 1990. Back then Margaret Thatcher was in power and interest rates were running at 15pc. Now they are at 0.25pc and there isn't much room for them to fall further.

So the Bank of England announced another round of quantitative easing. This time it will be £60bn. That is on top of the £375bn programme it conducted between 2009 and 2012.

With some of the juice of the Irish recovery seeping away there are massive challenges for the Government. The wheels have not come off our recovery, yet, but there are serious uncertainties ahead.

Yet the pressures to increase public spending, from demands for more Gardai to public sector pay demands, keep coming thick and fast.

This is a particularly bad time to have a weak government under a weakened Taoiseach. The Government is facing into a situation where it will have to make some very tough decisions. Yet, the tenor of this Government so far has been to keep making popular promises rather than face up to tough unpopular decisions.

Its Programme for Government was an uncosted wish list and seemed more Alice in Wonderland than realpolitik. The Fine Gael message of keeping the recovery going may not have been believed by the voters around the country - but it has made the trade unions ever more adamant that they want to see the benefits of the recovery being properly shared.

Unfortunately, by the time the industrial action is over, there may not be much left of this recovery to share out.

So far the Government has held its spending discipline. Public sector employee numbers have not risen that sharply and the Exchequer figures published last week show a relatively modest increase in public sector spending.

But how long can Public Expenditure Minister Paschal Donohoe, under the guidance of a Taoiseach desperate to stay in power, hold the line on spending demands?

Bank bailout is Ireland's financial Vietnam

When it comes to investment (and comedy) the most important thing is timing.

Billionaire Wilbur Ross and Fairfax's Prem Watsa delivered a master class in timing with their punt on Bank of Ireland. They bought in at 9c per share back in 2011. Ross sold three years later at 26c, while Fairfax bailed out a year later at 35c per share.

Brexit, bank stress tests and a generally tougher environment for bank shares, dragged Bank of Ireland stock down to 15c at one stage last week, before recovering to around the 18c mark. Somebody else, other than Ross and Watsa, has made money out of the Bank of Ireland share price with that kind of volatility.

Despite the efforts of Bank of Ireland to return to solid profitability, tackle legacy bad loan issues and control costs, its share price remains stubbornly below the levels enjoyed by Ross, never mind Watsa, when they cashed out.

Goodbody Stockbrokers' Eamonn Hughes took stock of the banking landscape during the week when he trimmed back price targets for all three quoted Irish banks.

After taking account of first half results and revised estimates for Irish GDP growth, he cut Bank of Ireland forecasts by 8pc -17pc, which led to a flat earnings forecast for full year 2016 to 2018. He also pushed the first dividend out to first half 2017 results and cut the price target by 27pc to 25c.

Underlying profit forecasts at AIB were cut by 7pc in full year 2016 and by 16 and by 13pc next year. He still sees plenty of extra capital on the balance sheet by 2018.

Meanwhile Goodbody opted for a €10m to €20m (10pc to 15pc) decline in forecast underlying net income at Permanent TSB from 2016 to 2019.

It also cut PTSB's price target modestly to €2.30 (-10c), which is said offered only "modest upside".

This is all bad news, not only for investors such as those who bought Fairfax's Bank of Ireland shares at 35c per share or PTSB's placing stock at €4.50 just 16 months ago.

It is bad news for the State - where its ownership of bank shares is looking increasingly like its Vietnam.

Kerry warning on Brexit is just the beginning

Kerry Group certainly won't be the last Irish food group to consider switching some future investment to the UK because of Brexit. The food giant said that some investment that might have gone into Ireland could now end up in Britain.

In the event that a full single market trade deal does not emerge, Irish food companies in particular will have to consider locating investments which serve the British market in the UK.

Bigger beef processors for example already have operations in the UK but continue to serve the UK market from operations in Ireland. If there is a complicated trade deal between the EU and the UK, it would make more sense to locate future expansion/investment for the UK market in the UK.

Smaller Irish food exporters may not have the scale or capacity to take this option and could find their businesses simply suffer. Some relatively small food companies or even start-ups aiming to target the British market may just up sticks and locate North of the border or across the Irish Sea.

We are only seeing the beginning of the long reach of Brexit in the food sector.

Sunday Indo Business

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