Austerity to weigh on Ireland in 2011

• Q3 GDP, released today, shows that the Irish economy grew by 0.5% qoq, but this masks a very divergent performance between export and domestic demand. 
• Exports are now 13% higher than in Q3 09, although domestic demand continues to be weak and has now fallen by 8% over the same period. 
• We believe that this pattern is likely to follow through into 2011, with GDP registering growth of only 0.9%, with the EUR 6bn in austerity measures taking effect. 
• Real-economy considerations are currently taking a back seat to the question of banks’ balance sheets. Markets will want to see unchanged loan-loss projections before they believe that there is no further liability from the banking sector for the sovereign.

Details

Q3 GDP, released today, shows that the Irish economy grew by 0.5% qoq, as export growth outweighed continued weakness in construction. While exports are now 13% higher than in Q3 09, total domestic demand continues to be weak and fell 8% over the same period. We believe that this pattern is likely to follow through into 2011, with GDP registering growth of only 0.9%, with the EUR 6bn in cuts likely to suck demand out of the local economy.

Consumer spending has been trending lower in 2010 and will weaken further in 2011, in the face of the 4% cuts in social welfare and the increases in taxes announced as part of the austerity programme. The level of Irish savings will remain elevated as households deleverage, contributing to the current account surplus witnessed in Q3.

In 2011, investment will continue to contract, although not at the rate seen in previous years. In 2010, this contraction was led by the fall in residential construction, but infrastructure spending will lead the decline in 2011, as the government cuts back on the large-scale public investment programme.

The Irish export sector should continue to perform well, building on its relatively strong performance over the last two years. The ongoing internal devaluation in Ireland has  lready delivered a 5% fall in wages and prices, which will boost competitiveness in the long run. However, in the short run this just reduces domestic demand further, putting pressure on households carrying fixed nominal mortgage debt.

These real-economy considerations are currently taking a back seat to the banks’ balance sheets question, which remains unresolved. As part of the EU/IMF agreement, the Irish Central Bank is to perform capital and liquidity assessments for the ‘living’ Irish banks in H1 11. Detailed asset disposal plans will have to be put in place by end-April 2011.

However, after previous increases in the cost to the State of bailing out the Irish banks, markets will want to see two or three unchanged loan-loss projections before they begin to believe that there is no further liability from the banking sector down the line for the sovereign. While the focus in 2011 may switch away from Ireland now that the EU/IMF package is in place, the country is unlikely to disappear from the front pages entirely. 

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Full report: Austerity to weigh on Ireland in 2011