It’s not 2007 but risks lie in unexpected places

At the turn of the year 2008, optimistic forecasts Ireland would merely suffer a soft landing as the debt-fuelled housing bubble deflated were about to be put to the test.

Employment had peaked at 2.16 million but had started to decline, and would fall by an enormous 330,000 over the next four years. Meanwhile, the US sub-prime mortgage crisis was spreading most vividly in the run on Northern Rock bank in Britain.

The reverberations from the US housing crash were being across global financial markets. Looking into the New Year 2008, economic prospects couldn’t have been bleaker.

Ten years on, the legacy of the financial crisis is still with us.

Long-term mortgage arrears remain largely unresolved. There are still 32,000 homeowners in Ireland that are now €79,000 behind on their mortgage payments - slowly progressing through the court system towards repossession.

The recovery in the construction sector is only beginning. Net emigration of Irish nationals has continued in every year since 2010. The damage from the last recession still has not been fully repaired.

More broadly, low-interest rates and quantitative easing remain in place.

The ECB is still pushing for banks to purge bad loans from their balance sheets.

European governments are still being advised to run budget surpluses to get their debt levels down.

Some argue the structural weaknesses of the euro have not been addressed, adding the cost of government borrowing for southern European countries has been artificially depressed by quantitative easing — diluting the impetus for reform.

In many respects, we have now come full circle.

The Federal Reserve is now raising interest rates, and the days of ECB’s easing programme are numbered. The Central Bank of Ireland and the Economic and Social Research Institute, and others, are now warning the Irish economy is once again in danger of overheating.

The message seems to have hit home with Taoiseach Leo Varadkar, reported to be considering holding back spare cash in the 2019 budget, if the economy continues to expand rapidly.

Is there really now a danger of overheating? The most obvious bottleneck is in the housing market.

Double-digit house price inflation and sharp increases in residential rents reflect the lack of housing supply. However, we are still a world away from the bubble created in the mid-2000s.

The median first-time-buyer is currently borrowing three times their income, compared with 4.4 times in 2008. Mortgage lending is under control, held in check by Central Bank lending rules. Homebuilding is close to 10,000 units per annum, still well short of demand and at its weakest level since the 1970s. Clearly, the recovery in homebuilding is still in its infancy.

Could Ireland suddenly lose competitiveness through a bout of wage-price increases similar to those in the early 2000s? The unemployment rate at 6% suggests companies will soon struggle to find workers, leading for wage pressures.

But for now, wage growth remains muted, at 1.7%. CPI inflation was just 0.5% in November, close to the lowest rate in Europe, and well below the 4% average through 2000-2007.

Ireland’s strong growth rates also reflect the depth of the recession. Employment may be expanding at 2% to 3% a year, but, at 2.06m jobs, is still 100,000 lower than its pre-recession peak in 2007. This may seem surprising. However, the fall in Ireland’s unemployment rate to 6% has been helped by emigration.

In total, 140,000 Irish nationals have left the country since 2010. Had more people stayed at home unemployment would be far higher. This merely illustrates Ireland’s labour market is extremely open — experiencing large net migration flows in and out, as employment prospects improve or deteriorate. Returning migrants will help alleviate skills shortages as they emerge.

The first obvious sign of a bubble is often in buoyant bank lending and credit growth. However, bank lending in Ireland continues to contract. Mortgage lending rose by 1.9% over the past 12 months to €104bn, at its lowest level since 2006.

Repayments on boom-era mortgage loans continue to outpace the small amount of new lending to the next generation of first-time-buyers. Clearly, households remain conservative, concentrating on paying down their debts.

In comparison, UK households have sustained their spending by reducing savings, and relying on credit card debt, balance transfers, instore finance or PCP. or Personal Contract Plan, car finance to sustain their spending. That’s one of the reasons the Bank of England raised interest rates in late 2017. However, there is little evidence of this type of behaviour in the Irish economy.

Irish companies, especially small medium enterprises, are also taking a sober view.

Bank lending to businesses stood at just €42bn in November, its lowest level in 15 years, down from a peak of €171bn in 2007.

Of course, this fall has reflected the transfer of property-related loans to Nama. Nonetheless, even excluding property, bank lending to Irish business has more than halved, from €60bn in 2008 to €27bn currently.

The 2007 general election meant there was never any real possibility of tax rises or spending cuts to cool the economy down.

Faced now with weak wage-price pressures and the ongoing contraction in bank lending, recent warnings Ireland’s economy is now overheating seem a little half-hearted, or are least slightly premature.

Of course, it is natural that we should want to avoid the mistakes of the past. The next generation of Irish homebuyers, if left unchecked, would probably be just as likely to take on too much debt as their predecessors.

Writing in the midst of the last financial crisis, shortly before the collapse of Lehman Bothers, the influential economist Paul De Grauwe warned there was a danger “central banks operate like a Maginot line”.

Specifically, while central banks had been successful in taming the runaway inflation rates of the 1970s and 1980s, they had neglected regulation of the financial sector and the enormous build-up of debt in European and US economies. Fighting the last battle had pointed central banks in the wrong direction.

Are we now in danger of placing too much emphasis on the past?

Most public debate on economic policy is inevitably framed within Ireland’s experience during the Celtic Tiger period — specifically the memory of wild increases in government spending, tax cuts and an unregulated financial sector.

But these memories may not serve us well in addressing upcoming challenges. For now, there is little debate on a range of key issues: The future of pension provision, the challenges of an aging population, much-needed reform of the planning system, and Ireland’s plans for public investment over the next 10 years.

Finally, as Brexit demonstrates, the challenges facing the Irish economy over the next 10 years may come from entirely unexpected sources.

- Conall Mac Coille is chief economist at Davy