Irish Economy Only Set to Grow by 0.1% in 2012: E&Y

Michelle Remo, “Big 4″ observer
March 23, 2012 /

An earlier prediction of the Irish GDP growth of 0.5% was revised downwards to 0.1% in 2012 due to continuing weak domestic demand and uncertainty in the Eurozone.

This was according to Ernst & Young, which downgraded its prediction for Irish economic growth in their quarterly Eurozone Economic Forecast (EEF) launched in Frankfurt.

Ireland has been the most successful of the five debt-laden EU economies in addressing its problems to date. It remains on target to meet deficit obligations of 10.6% set out by the EU and IMF.

The latest Ernst & Young Eurozone Economic Forecast (EEF) expects Ireland’s deficit to fall by 8.6% of GDP in 2012 in line with targets.
However, tighter fiscal policy, higher taxes and widescale public sector job cuts will now have a greater negative impact on economic growth in 2012 than previously expected.

Unemployment will peak at 15% in Q4 of 2012 and average 14.8% for 2013. In addition, ‘austerity fatigue’ will depress consumer confidence and spending is forecast to fall by 1.2% in 2012 and a further 0.8% in 2013. This weak demand will force companies to lower production and overall investment is set to fall by 5.9% in 2012 before starting to recover in 2013.

On the positive side, Irish exports remain on target to perform strongly with growth expected to average 2.1% in 2012 and 3.8% in 2013.

Marie Diron, senior economic adviser to the Ernst & Young Eurozone Forecast comments, “Although the recovery from recession is likely to be the slowest in Europe in the last 40 years the actions taken by the authorities over the last few months, particularly the introduction of the long-term refinancing operations by the ECB, have created conditions where it is possible to now see light at the end of the tunnel even if actual recovery is still some way off.

“These policy efforts have to be rigorously maintained and even reinforced at a Eurozone and national level to ensure we don’t lose momentum.”

Wider eurozone forecast

Ernst and Young predicts a mild recessionary fall in eurozone GDP of 0.5% this year, with nine of the seventeen eurozone members economies set to contract. However, the company expects eurozone GDP to grow by approximately 1% in 2013 before picking up to 2% a year in 2015-16.

Fiscal consolidation and lack of credit weigh on growth

The main constraints to Eurozone growth this year will stem from fiscal consolidation, which EEF estimates will amount to more than 1% of GDP, and tight credit. Despite the introduction of the long-term refinancing operations (LTRO), which has boosted financial markets and ensured that the prospect of a banking credit crisis has receded, latest data indicates that much of the liquidity provided has not yet been lent on into the wider economy.

Marie explains, “Eurozone banks are still facing difficult financing conditions, at a time when they need to achieve higher capital ratios. As long as banks are not passing on the liquidity borrowed from the ECB to businesses and households, credit conditions will remain tight dampening both investment and consumption.

“Indeed, there is a risk that credit constraints and fiscal austerity are more severe and protracted than we currently envisage; in this scenario, the Eurozone would experience a deeper recession.”

Lack of consumer and businesses confidence results in rising unemployment

In response to tighter financing conditions, an increase in spare capacity and weaker domestic demand, businesses are likely to scale back investment spending. Spanish and Italian firms are forecast to cut capital spending by 5% or more in 2012, while in France and Benelux investment will remain flat or edge down slightly. Amongst the larger economies, only in Germany is investment spending likely to grow meaningfully but not until the second half of the year.

Despite a moderation in inflation this year (assuming no further rise in oil prices), consumer spending is also likely to be reduced reflecting an uncertain external outlook and deepening fiscal austerity although perhaps by less than might be expected.

At the Eurozone level, EEF predicts that growth in consumer spending is likely to be negative at -0.7%. However, German consumers are likely to increase spending by around 1%, while French household spending will remain broadly flat.

This outlook for business investment and consumer spending means job creation is set to weaken in most Eurozone economies.

With Germany again set to be one of the few exceptions, EEF forecasts unemployment rates to rise across the Eurozone in 2012 peaking at 18.2 million at the turn of the year, although given the relatively strong balance sheets of many European corp–orates this trend could be quickly reversed if confidence begins to return.

‘ECB must continue to play its part to ensure recovery’

The ECB will continue to play a critical role in 2012 by providing extensive support to the Eurozone economy. Should the economic environment deteriorate, EEF believe this should include lowering interest rates further to 0.5% and stepping up purchases of government bonds to facilitate debt refinancing by peripheral countries at affordable interest rates. Without action, there is a risk of a series of disorderly defaults among weaker countries that could threaten the future of the Eurozone.

Marie comments, “Although the risk of a breakup of the Eurozone has fallen back since late last year thanks to the agreements on Greece and the involvement of the ECB it doesn’t mean that we have yet emerged from the crisis.

“At best, 2012 will be a difficult year for governments, businesses and households alike. Even the weak recovery forecast for next year should not be taken for granted given the substantial problems the region faces over the next 12 months.”

EEF is optimistic however that the Eurozone policy community will tackle these challenges successfully and avoid any permanent structural damage to the currency. Nevertheless, given the impact of the crisis on banks’ balance sheets, and the weakness of public finances in many countries, the recovery will be much slower than after previous downturns.

The scale of current crisis could also be the trigger for Eurozone-wide reforms that would have otherwise been considered too difficult to implement. Real structural change to encourage medium and long term growth to enable the region to compete with developing markets is in many cases long overdue.

Marie concludes, “The Eurozone needs to do more to improve the economic outlook beyond 2013. Tackling rigidities in the labor market, improving the quality of institutions in some countries, taking difficult decisions on the care of ageing populations, and encouraging a single market for services would all go a long way toward improving long-term growth prospects.

“By taking these steps now, Eurozone governments would also take a big step towards easing the current crisis and help prevent the next.”

 

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