A fall in exports and lower consumer spending in the face of higher inflation will lower the growth rate in the economy this year, according to the Economic and Social Research Institute.
In its latest Quarterly Bulletin, the think-tank also cautions against any cuts in taxes in the upcoming Budget that go beyond keeping pace with inflation.
Exports of goods by multinationals in the pharmaceutical and computer chip industries have fallen sharply this year.
The reasons include less demand for vaccines post-pandemic and trade restrictions placed on US companies selling certain goods into China.
The knock-on effect on multinationals exporting from Ireland is a forecast fall in GDP this year of 1.6%.
That would be the first contraction in GDP in over a decade, but the domestic economy is expected to continue to grow by 1.8%.
GDP, as a measure of the economy, includes the activities of multinationals.
The ESRI report said GDP has exaggerated growth in the economy in the past, but it is now understating the level of growth in the domestic economy.
However, forecast growth in the domestic economy has also been downgraded slightly. One reason is the effect inflation is beginning to have on consumer spending. Also, higher interest rates are reducing investment.
On inflation, the ESRI now believes that Consumer Price Inflation will average this year at 6%, before slowing to 3.2% next year.
Its report said inflation is now broadening and becoming more ingrained across the economy with more so-called “second round effects”.
This is where the costs of other goods and services catch up with the “shock” caused by the dramatic increase in energy prices last year. Also, the price of oil has steadily risen since the summer.
The ESRI expects incomes to grow by 4.8% this year and 5.8% next year.
Speaking at a press briefing, Kieran McQuinn, Research Professor with the ESRI, said it would be “a good idea” for any government that outlined a spending rule to stick to it and it would “not be a healthy sign” if it did not.
However, he said it was “arguable” that the economy had grown by much more in recent years than the current spending rule implied so there could be a case for catch-up capital expenditure to keep pace with growth.
Prof McQuinn said it is important the Government “holds the line” on tax and only introduces cuts that keep pace with inflation to avoid “fiscal drag”.
This is where workers whose wages go up end up paying more in tax if they move into a higher tax bracket. Moving the entry levels to different rates avoids this.
The ESRI has factored in a surplus of €8 billion in the public finances this year and €13.2 billion next year.
The forecasts have included a contribution in both years of €4 billion to a Government investment plan, the details of which are expected on Budget Day.
Speaking on RTÉ’s Morning Ireland, Prof McQuinn has said that a number of factors are at play that are causing the economy to stall.
He said GDP is likely to fall this year, but the underlying situation is somewhat different, and “that’s often the case as far as the Irish economy is concerned.”
Prof McQuinn said the economy is growing this year and it is thought it will grow next year.
He said: “The issue is that it’s probably not growing as fast as it was in the immediate aftermath of the pandemic.
“And there’s a number of reasons for that. The Irish economy was somewhat exceptional in that it grew very strongly in the aftermath of the pandemic, mainly because sectors such as the ICT, pharma, which are hugely important to the domestic economy, happened to grow very strongly at that time.
“So, it’s not unexpected that the pace of those sectors would start to slow and hence the economy would start to slow.
“The other important consideration as well is that we have experienced globally a very, very contractionary monetary policy over the last year.”
Prof McQuinn said that interest rates have gone by over four percentage points in the last year.
“That has a quite a negative effect on economic activity. That’s the whole purpose of raising interest rates to a certain extent.
“It’s inevitable that the Irish economy, a small open economy, is going to be affected by that,” he said.