The Economic and Social Research Institute (ESRI) has downgraded substantially its outlook for growth in Gross Domestic Product terms for the Irish economy, but it says the underlying position of the economy is still very strong.
The ESRI says the domestic economy – as measured by Modified Domestic Demand (MDD) – is expected to experience strong growth both this year and next.
In its latest Quarterly Economic Commentary for Summer 2023, the institute is forecasting growth in MDD of 3.6% this year and 4% in 2024.
It points to the labour market operating near full capacity with the unemployment rate falling to 3.8%, according to the latest official figures, and an average unemployment rate of 4% anticipated for this year and next.
Household consumption remains robust and is stronger than what was predicted earlier this year.
The downgrade in the outlook for GDP growth is accounted for by a somewhat unexpected slowdown in export activity, particularly in the pharmaceutical and chemicals sector, and a subsequent increase in imports.
While concerns had focused on the ICT (Information and Communication Technology) sector due to a downsizing of employee numbers in the industry, performance has held up well and was in line with expectations.
The institute is forecasting GDP growth of 0.1% this year and 3.5% next year.
Export growth is expected to moderate to just over 4% this year, rising to just over 5% in 2024.
It says it will examine closely over the coming quarters if this is a one-off change as a result of transactions by a small number of multinational firms or if it is part of a wider trend driven by international factors such as the rising interest rate environment or currency movements.
The ESRI forecasts a significant moderation in the inflation rate in the year ahead as price pressures ease, particularly in the energy market.
However, it points out that core inflation, which strips out volatile elements such as energy, remains “stubbornly” high both for Ireland and internationally.
On the housing and construction side, the institute forecasts a reduction in expected housing unit completions this year with around 27,000 units completed – down from close to 30,000 units completed last year.
It pointed out that there had been an acceleration in housing starts in the early months of 2023 following on from a slowdown last year which should feed through to a rise in housing completions in 2024.
Together with changes in the interest rate environment, it is impacting performance in the property market.
“Rising interest rates are likely putting downwards pressure on the housing market,” Dr Conor O’Toole, ESRI Associate Research Professor said.
“Over the past few months, the growth rate of house prices has decelerated quite rapidly. When you adjust for inflation, in real terms, house prices are coming down,” he added.
The institute is forecasting continued growth in household spending, driven by an increase in wages and the high savings rate that has persisted across the economy since the pandemic.
It foresees a moderation in the savings ratio in the months ahead but continued strong growth in the labour market.
“That does give rise to accelerated wage pressures. We see wages growing this year by around 5% and 6% next year,” Kieran McQuinn, ESRI Research Professor, said.
“That is quite a pickup in wage related costs.”
He pointed out that strong wage growth in the multinational sector was putting pressure on wages in the domestic sector, which he said gave rise to competitiveness pressures, particularly for domestic firms.
On the public finances, Professor McQuinn said a close eye would be kept on whether a slowdown in exports in the pharmaceutical sector would translate into lower corporation tax receipts.
It forecasts continued strong receipts for the Exchequer, which is playing a significant part in reducing the debt to GDP ratio.
The institute expressed concern around the potential for overheating arising from capacity constraints in the economy and the availability of excess cash in the Exchequer, mostly as a result of higher-than-expected corporate tax receipts in recent years.
“The Government is in a very tricky position in order to address the infrastructural issues that are there… with particular issues around housing and healthcare”, Professor McQuinn said.
“The challenge is to address those [issues] without overheating the economy, which is very difficult to get right,” he added.
He said the key was to invest in the productive capacity of the economy and to address key infrastructural bottlenecks, such as housing.
Unemployment is at its lowest at 3.8% according to records, Prof McQuinn said but he added this also highlights how people are having real difficulty trying to source labour.
“Where you see it coming through in terms of the implications, you see higher wage rates and we are expecting wage rates to grow by around 5% this year and 6% next year, and so that is all adding to the costs in the economy.”
He said inflation rates have already been growing, mainly due to factors outside of “our control” as he referred to the pandemic and the war in Ukraine.
“I think what you might see over the coming period of time is as those inflationary pressures ease, domestic inflationary pressures could gather apace because of the underlying strength and growth of the economy.”