11 Jul 2019

Irish Economy: European Commission refreshes growth forecasts

The European Commission (EC) yesterday released its Summer 2019 European Economic Forecast report. 

At a headline level, the EC left its 2019 forecasts for both the Eurozone (GDP +1.2%) and EU28 (+1.4%) unchanged. For next year, the EC continues to see the EU28 expanding by 1.6%, but it has marginally trimmed (-10bps) its Eurozone projection to 1.4%. Unsurprisingly, the growth outlook is seen as being “clouded by external factors”, with “the recent escalation in trade tensions and the corresponding uncertainty is depressing already weak global activity, particularly in the manufacturing sector”. Recent Irish economic releases such as the Manufacturing PMI show that this country is already seeing such pressures. 

 

With that being said, the Irish economy is still expected to be towards the top of the EU ‘growth charts’ over the forecast horizon. Ireland had the fastest headline growth in the EU28 in both 2017 (GDP +7.2%) and 2018 (GDP +6.7%, tied with Malta), while for 2019 it is expected to be the joint third (with Romania) fastest-growing economy with GDP expansion of 4.0% projected, moderating slightly to 3.4% in 2020. For the record, Investec projects Irish economic growth of 4.3% this year and 3.4% in 2020, so we are broadly in line with the EC’s thinking. 

 

The report notes the very strong labour market (employment +3.7% y/y in Q119, unemployment back to pre-recession lows) trends in Ireland, which are contributing to a meaningful (+3.4% y/y in Q119) advance in headline wages, supporting household disposable income and, by extension, private consumption. When this is allied to continued strong growth (albeit from a relatively muted base) in construction output, “domestic activity is projected to continue growing at a solid pace”. Chief among the risk factors are, unsurprisingly, Brexit and changes in the international taxation environment, while domestically “in the absence of major negative external shocks, the risk of overheating could increase in the near term”. The EC’s report chimes with our take on headline growth and risk factors. 


Irish Economy: Residential prices rise 0.5% in May 

The latest Residential Property Price Index (RPPI) release from Ireland’s CSO shows that residential prices rose 50bps m/m in May, the fastest pace of growth in the current three month sequence of expansion. On an annual basis, however, prices were +2.8%, the slowest pace of growth on this measure since July 2013. 

 

This latest increase brings the cumulative recovery in prices since the early 2013 trough to 82.6%, led by Dublin where prices are now 93.4% above their respective low point. Despite this uptick, national prices are 18.2% adrift of their 2007 peak, with prices in the capital 21.9% off their respective high water mark. This peak-to-current delta compares favourably with the 30-40% assumption that we understand the domestic banks have incorporated into their provisioning models. 

 

In terms of regional trends, Dublin prices rose 80bps m/m (the first monthly rise this calendar year) but on an annual basis prices in the capital were up just 0.6%. Outside of Dublin prices were +0.2% m/m and +5.1% y/y. The divergence in the annual performance is, in our view, driven by the Central Bank’s macro-prudential mortgage rules, which slap strict LTI and LTV ceilings over the majority of front-book lending. Asking prices in Dublin, per Daft.ie data, are 44% above the national average, while disposable incomes in the capital are only 18% above the average for the State.

 

We suspect that the relatively strong move in prices during the month of May, especially in Dublin, at least partly reflects a ‘Brexit bounce’ due to the postponing (for now at least) of the UK’s departure from the European Union from the original end-March date. With the mismatch between supply and demand in the Irish housing market likely to endure for several years, our view remains that the path of least resistance for rents and capital values lies to the upside.


Irish Economy: Headline inflation at 1.1% in June

The latest CPI release from the CSO show that prices on average were +1.1% y/y in June. Prices rose 0.2% during the month.

 

In terms of the contributions to the annual change in the CPI, the narrative is one of upward pressure from Services (+1.48% y/y) prices being partly offset by a 0.41% y/y decline in Goods prices. 

 

Three sub-items that we closely track are Private Rents, Insurance and Accommodation. Taking those in turn, Private Rents were +30bps m/m and +5.5% y/y, reflecting the continued mismatch between residential supply and demand (see our RPPI comment for more on this); Insurance prices were flat during the month but -90bps y/y, responding to positive developments in the claims environment; and Accommodation Services prices were +4.2% y/y, with the removal of the special low VAT rate on hospitality services from 1 January likely to be a key driver of this. 

 

Headline inflation is running at only a third of the rate of wage inflation (+3.4% y/y), producing a meaningful lift to household real incomes. This has positive read-through for sectors exposed to the Irish consumer.


Irish Banks: Ulster Bank cuts variable rate 

According to reporting in The Irish Independent this morning, RBS’s Ulster Bank subsidiary has cut its main standard variable rate (SVR) applying to residential mortgages, in a sign that the recent sharp drop in wholesale/bond yields may lead to a fresh wave of mortgage rate cuts for consumers in the Irish mortgage market. 

 

Ulster Bank is set to drop its SVR by 40bps to 3.9% (which should have automatic pass through to other variable rates which are priced off the SVR), the first cut to its standard SVR in a number of years, with the bank competing for new business via highly competitive fixed rate mortgage pricing in recent years. While almost no new business is conducted via the SVR product, it is typically the default rate, which fixed rate customers roll on to after the end of their fixed rate period, and as such tends to apply to customers for a period of inertia until they choose a new product. 

 

We see a rising probability that the other main high street banks may also seek to tweak their mortgage pricing in the coming months given the sharp drop in bond and swap rates and the rising potential for an easing of ECB policy rates. All else being equal, this would likely act as a headwind to margin expansion in the sector given the difficulty in passing through lower wholesale/policy rates to deposit customers. 

 

Powell signals July rate cut

Fed Chair Powell’s testimony to the House Financial Services Committee reiterated that the Fed would “act as appropriate” whilst flagging that key uncertainties around trade tensions and the strength of the global outlook “continue to weigh”. In addition, there were further signs that the Fed will be more responsive to the run of below target inflation, something that also came across in his Q&A session with the Committee. 

 

In terms of the June meeting minutes, there was also an indication that the Fed would be worried that disappointing market expectations of interest rate cuts could be an impediment to growth as they stated that whilst “overall financial conditions remained supportive of growth those conditions appeared to be premised importantly on expectations that the Federal Reserve would ease policy in the near term”. The Federal funds futures curve is now (again) pricing in three cuts in rates by the end of the year. Note that the move by the Fed, particularly its sensitivity to low inflation but also to the evolution in the global risk backdrop, appears to be finding its way into the thinking of other central banks, not least the ECB, but also to the Bank of England (BoE). Comments from external BoE member, Silvana Tenreyro yesterday set out her view that the weaker global outlook would also lengthen the period until there is enough inflation pressure for her to vote for a hike.


Fed minutes

The minutes to the June FOMC meeting were published last night and, taking on a cautious tone over the global backdrop, added further weight to expectations that the Fed is set to put through a precautionary cut in the Federal funds rate on 31 July. We now judge that the funds range will be lowered from 2.25-2.50% to 2.00-2.25% at that meeting, whereas previously we had judged it likely that the FOMC would have waited until September to make its first easing move. 


RICS housing survey (June)

Results of the June RICS survey pointed to a continued improvement in the UK residential housing market. 

 

The headline house price balance rose from a revised -9% to -1%, beating both consensus and Investec expectations (-12% and -8% respectively). Activity metrics also improved, with new buyer enquiries rising for the first time since November 2016 and the newly agreed sales balanced edging into positive territory for the first time in 10 months. Despite the June improvement, RICS's Chief Economist cautioned that surveyors were not hopeful of “a significantly more active market going forward” and suggested that the improvement seen in recent months stemmed largely from the ‘Brextension’ to 31 October.


TOTD

UK GDP rose by 0.3% on the month in May, matching consensus expectations, but failing to fully reverse the 0.4% drop in April.  Our own forecast had been for a bigger 0.5% rise in output. However, the services sector logged a disappointing flat month-on-month print, albeit with output in April revised up to +0.1% from flat. Manufacturing output also disappointed rising by 1.4% on the month (consensus 2.2%, Investec forecast 2.5%), failing to unwind the downward revised -4.2% m-o-m fall in April, amidst earlier than normal auto sector shutdowns.

 

Coming off the back of a weak April, the May figures paint a picture of a UK economy lacking momentum with a risk of a negative GDP print for Q2 overall.


Economic Releases

10.30 UK BoE Financial Stability Report

11.15 EZ ECB’s Coeure Speaks

12.30 EZ ECB meeting minutes

13.30 US CPI

15.00 US Fed Chair Powell Testifies

16.10 US FOMC Member Williams Speaks

17.00 US WASDE

17.15 US FOMC Member Bostic Speaks

17.15 US FOMC Member Barkin Speaks