Ireland and Spain face a prolonged slowdown in economic growth, according to US ratings agency Standard & Poor's, as a drop in construction activity and consumer sentiment hits labour markets and weakens public finances.
Standard & Poor's says in a report published on Monday*, that house prices in Ireland , Spain and the UK have been among the fastest-growing in Europe over the past decade.
"These countries are now leading the subsequent downturn," the agency says.
S&P says house prices in the three countries are about 20 per cent overvalued and on the verge of a "protracted correction".
The impact of the expected correction in the housing market, would be more pronounced in Ireland and Spain, whose "economies are heavily exposed to the direct effects of the housing market slowdown on the construction sector", the agency says as construction accounted for 12.6 per cent of the total employment in Spain in 2006 and 13.0 per cent in Ireland, compared with a European Union average of 8.2 per cent, it says.
In a situation where activity eases gradually, the Irish economy will grow by 3.8 per cent next year, following growth of 5 per cent this year, according to S&P.
If construction sector output slows very sharply, however, this growth could fall to 1 per cent in 2008 from 4.8 per cent this year, Standard & Poor's finds.
It sees a sharp contraction as similar to what the UK experienced in the late 1980s after the housing market boom in that country, or the slowdown seen in Germany after reunification.
Unemployment in the Spanish construction sector has risen 53 per cent in the past 12 months, and the number of immigrants out of work has risen by 22 percent.
In a best-case scenario, Standard & Poor's sees gross domestic product growth in Spain slowing to 2.5 per cent in 2008, from 3.7 per cent this year. This compares with official estimates of more than 3 per cent.
"Under the benign assumption the construction sector as a share of GDP will moderate gradually back towards its 10-year average ... both Ireland and Spain are likely to experience a significant slowdown in GDP growth, beginning in 2008," says Standard & Poor's.
The agency says that it would take until 2015 to regain the growth rate that both countries could be expected to achieve in 2008, in a more orderly construction slowdown.
This suggests that Irish GDP growth would remain below 4 per cent for seven years after a severe slowing in construction.
"A sharp downturn would have a much more debilitating effect for medium-term growth in Ireland and Spain," the report says.
Standard & Poor's also says that the heavily-indebted nature of the Ireland's private sector (203 per cent of GDP) poses "significant risks over and above that of a construction sector slowdown".
*not currently available online.