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News : Irish Economy Last Updated: Dec 15, 2010 - 5:19 AM

Irish economy forecast to contract again in 2011; Unemployment will be at 14% in 2014; Strong growth possible in longer-term
By Michael Hennigan, Founder and Editor of Finfacts
Dec 14, 2010 - 4:37 AM

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A forecast for the Irish economy published today says 2011 will be another year of recession; unemployment will be as high as 14% in 2014 despite high emigration but a leaner, more competitive Ireland should be in a position to return as one of the stronger growing Eurozone economies in the longer-term.

Big 4 accounting firm Ernst & Young’s Winter Eurozone Forecast (EEF) says the Irish government assumes GDP (gross domestic product) growth will average 2.75% in 2011-14. By contrast, the EEF sees on average only 0.8% growth per year during that period.

The  forecast comprises another year of recession in 2011, with GDP declining by 2.3%, after a shrinkage of 1.5% in 2010, and before climbing gradually to growth of 2.5% in 2014. In the forecast, employment is not expected to increase until 2013 and Ireland’s unemployment rate is expected to still be as high as 14% in 2014. This bleaker unemployment outlook than presented by the Government holds despite a cumulative working age population net migration outflow of 170,000 persons between 2010 and 2014.

Ireland will remain amongst the bottom three performers in terms of employment growth between now and 2014 with an average annual employment rate of 14.7%, just ahead of Greece (14.8%), well ahead of Spain (19.8%) and in comparison to the Eurozone average of 9.6%.

The EEF says that the main drag on Irish GDP growth in the next two years will come from a drop off in domestic demand. Beside the direct negative impact of the fiscal measures, growth will be dampened by a range of related factors that include a large out migration flow of people (and their skills and spending) and a likely rise in retail interest rates that will impact on consumer spending and housing repossessions.

Domestic demand is forecast to fall by 4.7% in 2011 and a further 2.2% in 2012, with falls in consumer spending of 4.3% and 2.2%, and investment of 9.5% and 2.4% respectively.

Marie Diron, senior economic adviser to the Ernst & Young Eurozone Forecast comments, “If the short-term challenges can be managed and overcome, while maintaining a long-term strategic focus, then a leaner, more competitive Ireland should be in a position to return as one of the stronger growing Eurozone economies. This currently seems a long way off and the Irish government and economy will have to overcome numerous hurdles in the meantime.”

The EEF says the Eurozone economy has put in a robust performance for much of 2010 but a slowdown is expected next year with GDP growth only reaching 1.4%. However, growth is expected to be very uneven across the 16 countries. And with major downside risks looming, the ECB needs to stand ready to implement additional significant measures to support the European economy in case of a crisis.

Eurozone Winter Forecast including Ireland

Recent government assurances that Ireland will keep its competitive corporation tax rate of 12.5% will help the country in attracting foreign direct investment, Barry O'Leary, CEO of IDA Ireland, told CNBC. O'Leary considers the outlook for foreign investment into Ireland:

State agency Forfás reported last March that total permanent full-time employment in the manufacturing and internationally traded services sectors amounted to 272,053 in 2009. It was 276,287 in 1998. Employment in foreign-owned firms was 132,596 in 2009 and 140,281 in 1998.

More than 50% of merchandise exports are from the chemical sector; these goods have a high import content and the sector employs less than 30,000 in a workforce of over 2m.

See: Finfacts article: Foreign-owned firms accounted for 91% of Ireland's tradeable exports in 2009; Food & drink exports fell 15%

Eurozone GDP growth in 2010 is estimated to be 1.7%, slightly better than EEF had expected earlier in the year but a look at the composition of growth offers little room for complacency. Restocking has accounted for 80% of growth this year but by its nature this is temporary and going forward will disappear. Much of the slowdown in 2011 is accounted for by fiscal tightening, which EEF estimates will amount to more than 1% of GDP.

Marie Diron said, “The Eurozone is likely to muddle through this crisis. However, even in this best-case scenario growth is heavily reliant on the Northern countries of the region. Inevitably there will be growing divergence with the South. Moreover, each episode of turmoil on financial markets makes much worse scenarios more likely to happen.”

3 speed Europe

Germany is driving the Eurozone economic recovery with GDP growth of 3.5% forecast this year and 2.1% next with pre-crisis levels of GDP to be reached by the end of 2011, much sooner than originally expected. Both exports and more recently, domestic business have contributed significantly to the recovery in Germany. Countries closely linked to the German economy, in particular Slovakia (2.8%) and Austria (2%) are also predicted to grow steadily in 2011. More modest growth is forecast in other major ‘Northern’ countries including France and Netherlands (both 1.8%).

EEF forecast GDP growth in the peripheral countries in 2011 to range from -3.3% in Greece to -0.7% in Portugal. This could be considerably lower if the peripheral economies face renewed turmoil in bond markets and need to implement yet additional deficit tightening measures.

Worst case scenario points to a renewed crisis

The usual uncertainties around any forecast of the Eurozone are exaggerated by the current sovereign debt crisis. EEF estimates a probability of only 45% for the relatively benign growth of 1.4% in 2011. Also likely (25%) is a more sluggish recovery as weakening domestic demand is compounded by banks struggling to mend their balance sheets in the face of further stress tests. Here GDP growth struggles to reach 1% in 2011 and only 0.8% in 2012, compared to 1.4% and 1.7% respectively in the baseline.

A worst case scenario (estimated at 10% probability) is that an escalation of the sovereign debt crisis would lead to a significant restructuring of peripheral Eurozone government debt and could ultimately lead to a full-blown financial crisis. EEF has forecast, if this were the case, GDP growth for the Eurozone would be significantly negative, as low as -2% to -3%, for a couple of years and more than cancel out any recovery seen to date. If such a crisis were to occur in 2011, Eurozone GDP would still be around 3.5% below pre-crisis levels at the end of 2014.

Mark Otty, Area managing partner, Europe, Middle East, India and Africa for Ernst & Young said, “The unpredictability of the economic situation across the Eurozone is making it increasingly difficult for corporates to plan ahead. As pessimism prevails around GDP growth in many parts of Europe businesses remain conservative about future investment and recruitment plans.”

Leaders of Germany and France met to plot strategy before a key EU summit. Richard Cookson, CIO for Citigroup Private Banking, joined CNBC for more on the European crisis:

Quantitative easing could raise GDP by 2% by 2012

The European Central Bank (ECB) has appeared to close the door on following the US Federal Reserve and engaging in quantitative easing to boost the economy. However, EEF believe that if the Eurozone is hit by a new crisis, the ECB should be ready to reinstate aspects of the liquidity measures of 2009 and 2010 and should not rule out quantitative easing.

The impact of the Fed’s second quantitative easing (QE2) phase, in the United States, has shown significant potential positive effects for the US economy. This is supported by observed changes in US financial markets since the announcement of QE2. The ECB’s New Area-Wide Model suggests that the impact of quantitative easing in the Eurozone could be even more significant than in the US, raising GDP by about 2% by 2012. Further positive effects would result from higher share prices and a weaker euro.

Diron comments, “It is a concern that the ECB appears to have rejected outright the option of using quantitative easing. It could then be left with very little effective ammunition to counter the negative impact of a renewed Eurozone sovereign debt crisis as it is difficult to see how it would achieve such effects using its current set of tools. A ‘plan B’ for Eurozone monetary policy is needed given the downside risks to growth.”

Interest rates to remain low until the end of 2011

Diron comments, “The robust growth results of the first part of 2010 may have encouraged the ECB to believe that the recovery was well engaged and that the Eurozone could support tighter monetary conditions. However, the Irish crisis has highlighted the fragility of the Eurozone economy and the need for monetary policy makers to use all weapons available to buffer the negative impacts. The ECB needs to continue to monitor the highly uncertain impact of fiscal tightening and developments in financial markets to stand ready to provide more support if required.”

EEF believes that given monetary conditions have tightened significantly since the spring as the ECB has started to wind down its lending to the Eurozone banking sector, pushing interbank rates up, interest rates should not be raised until the latter part of 2011.

Labour market concerns

The EEF says divergent economic conditions are particularly apparent in the Eurozone labour markets with current unemployment rates ranging from 4.3% in Austria to 20.5% in Spain. This divergence in unemployment rates is expected to remain high over the next few years. Employment rates in the peripheral countries are expected to be flat at best, dampened by cuts in public sector jobs and the negative impact of the tighter government budgets on the private sector.

Meanwhile, in the rest of the Eurozone, employment growth is expected to pick up modestly through the course of 2011. Overall, these divergent conditions support that the level of unemployment in the Eurozone as a whole is unlikely to fall over the next year or so. EEF do not expect the number of unemployed in the area to fall below 15 million before 2013.

Challenging times ahead as downside risks remain high

Diron concludes, “The level of growth experienced in 2010 is unlikely to follow through into the new year as downside risks remain high. Further worsening of the turmoil on Eurozone bond markets is possible given ongoing concerns about public finances and banking sectors. If this led to sovereign defaults, the Eurozone would likely be plunged back into recession. Against this backdrop, the ECB needs to keep monetary policy accommodative for some time and be prepared to step up the range of tools that it uses.”

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