Source: Davy Research

Irish Economy: Davy Research said today that the economy is set to contract sharply in both the rest of 2008 and 2009. GNP is expected to decline 2% in real terms this year. Next year, the economy may shrink by 3.4% in volume and by 3.5% in nominal terms - the biggest plunge since the 1950's.

Rossa White, Davy economist, said that economic prospects will not be helped by a combination of factors:

• The decline in construction activity will continue. House completions will slip to 25,000 from 50,000 in 2008. New completions of commercial buildings are also likely to fall. Meanwhile, public capital spending is set to decline 8% year-on-year.

• The severe credit squeeze will continue as banks struggle with nonperforming loans to the construction sector, hurting business investment and consumer spending. Employment may drop by 4%

• and the unemployment rate may reach 8.5% by the end of 2009.

• Inflation will decline to 1% or lower, which will help. But the loss of financial and property wealth over the last year, plus deteriorating labour market prospects, will lead to a further rise in the household savings ratio.

• Export demand will wane, reflecting lower consumer spending in the UK, US and much of the euro area. Low-tech manufactured goods and food products destined for the UK will suffer. In addition, Davy expects financial and business service exports to take a particular hit as a result of the ongoing fallout from the banking crisis.

• Looking to 2010, the outlook is clouded. The crucial variable is how the domestic financial system responds over the next 12 months. If bank lending to credit-worthy businesses and households picks up, the recession will not be prolonged indefinitely. But that is far from certain.

• The worry is that credit contractions tend to be pro-cyclical and lengthy.

Davy says upshot of rising deficits and the shrinkage of the real economy is that the general government debt to GDP ratio will increase significantly in 2008 and 2009. In 2007, the Irish debt ratio was the second-lowest in the euro area at 24.8%. Based on Davy estimates, the ratio will head towards 40% by end-2009. In total, the combined GGB borrowing requirement may exceed €25bn, and interest payments will continue to nudge up due to increased borrowing costs on top of the higher debt level. Yields on Irish government debt are set to increase, in part due to the contingent liability of the government guarantee of most borrowings of Irish banks.