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Quarterly Bulletin

Central Bank warns poor housing supply is a 'constraint' on Irish economy

The Bank revised its consumer price inflation forecasts down to 5% due to a more positive outlook for energy prices this year.

THE CENTRAL BANK has said the lack of housing supply in Ireland is “a constraint on economic activity” as it revised its consumer price inflation forecasts down to 5% due to a more positive outlook for energy prices for the year ahead.

The regulator has said that the a lack of housing supply may be a focus of firms in Ireland, with the availability of housing seen as “one of the big considerations” for companies operating here.

Last October, the Bank revised its consumer price inflation forecasts up to 8% for the year, saying it reflected sharp increases in future prices of gas on wholesale markets. 

In its latest quarterly bulletin, published today, the regulator said inflation is expected to remain on a downward trajectory over the forecast horizon, but that uncertainty remains high over its precise path.

It also said there will likely be a drop in the number of housing completions this year due to increases in construction costs and labour and material shortages.

It said that the global economic backdrop has performed better than previously expected, and that the Irish economy is showing “continuing resilience”.

“As the year progresses, amidst a tight labour market, household real incomes are expected to recover gradually, supporting underlying growth in the domestic economy,” Robert Kelly, the Central Bank’s director of economics and statistics, said.

He noted that while consumer inflationary pressures are easing, inflation is expected to remain high this year and next year, though at lower rates than previously forecast.

“With the economic implications of the Russian war in Ukraine still present, a combination of mild weather and policy actions helped the European economy fare better than expected in recent months.

“In Ireland, headline inflation has eased from its most recent peak of 9.4% last autumn, as the effect of the spike in energy prices abates. Price levels, however, remain significantly higher than before the war and the COVID-19 pandemic.”

Despite the wholesale price of energy falling in recent months, bills for consumers have remained high and show no sign of reducing. 

Last week, Finance Minister Michael McGrath said energy companies should pass on reductions in the wholesale market to customers, both households and businesses.

His comments came after Electric Ireland announced that it was decreasing electricity bills for business customers by an average of 10% without announcing any similar cut for households.

Housing

The Central Bank said there was a stronger than anticipated outturn of housing completions in the final quarter of last year, with completions for the year totalling almost 29,000.

However, it said forward looking indicators would suggest that completions this year will be lower. 

New completions are forecast to be constrained by labour and material shortages, as well as continued increases in construction input costs.

Screenshot (235) The bank said there was some weakness in planning permission and commencements figures throughout 2022. CSO / Central Bank of Ireland CSO / Central Bank of Ireland / Central Bank of Ireland

House completions are forecast to number around 27,000 this year, increasing to 29,500 next year and 32,500 in 2025.

Asked about its forecast for housing going forward, Kelly said it’s “inherently difficult right now to forecast the property crisis, but what we do know is that there’s factors at play on the demand side”.

“What we are seeing in the bulletin is relatively good numbers this year in terms of housing supply – they’re up – but when we look into the future, given the rise in construction costs and also the outlook for interest rates, we’ve revised down the number of completions.

“And given that we have a demand and supply imbalance within the property market, and it’s a cumulative one, it will put Ireland in a slightly different position than you maybe would think naturally, as you see the rise in costs and the affordability diminishing for households.”

Kelly said the lack of housing supply ”is unique in the Irish setup that we have”, and suggested it has become a strain on the Irish economy. 

“I don’t necessarily want to put a year on it, but you’re talking about multiple years where we simply haven’t been supplying the number of houses we need based on demographics for example, and we are at a point now where it is a constraint to economic activity.

“When we talk to firms in terms of the market intelligence, they will point to availability of housing as one of the big considerations when you’re talking about labour for example, so when you think about those factors and trading them off, Ireland is unique in terms of the imbalance between demand and supply.”

Inflation

The Central Bank said inflation has eased in recent months partly due to measures such as reduced public transport fares and third level education fees.

“Given the market expectations for wholesale energy prices, and the likely lagged pass-through to consumer prices, headline inflation is expected to be lower than expected previously and continue on a downward trajectory over the forecast horizon,” it said. 

Screenshot (234) CSO / Central Bank of Ireland CSO / Central Bank of Ireland / Central Bank of Ireland

Consumer price inflation is forecast to fall to 5% for 2023 and is also expected to drop further to 3.2% in 2024. 

The Bank said the more positive outlook for energy prices compared to the previous forecast last October is the main factor underlying the downward revision.

“Energy price rises are expected to be a much smaller feature of headline inflation developments in 2023, whereas food and more domestically generated services inflation becomes more prominent,” the Bank said.

It also said that futures prices for oil and gas on international markets have fallen markedly since the last bulletin in October, which reflects a reduction in uncertainty about supplies that had emerged since the onset of the war in Ukraine.

However, the effect of the energy price shock is still expected to be seen in the price of other goods and services throughout the year, with inflation excluding energy of 4.3% expected for 2023, easing to 2.9% in 2024 and 2.6% in 2025.

Domestic policy

The Central Bank said domestic policy has a “significant role to play” in how the economy adjusts to the negative supply-side shock brought on by the Ukraine war has brought about and its negative consequences for national income and the medium-term productive capacity of the economy.

“There have been particular challenges since the war came about at a time when there was already considerable adjustments occurring in global and domestic demand and supply conditions arising from the response to the COVID-19 pandemic,” the Bank said.

“Cost-of-living measures to mitigate the near-term impact of higher inflation have been significant, and in part targeted at those most vulnerable to the costs of the immediate shock.”

It said ensuring these temporary measures are unwound “in a timely fashion” will reduce the potential of adding to further medium-term inflationary pressures and potentially creating a longer-term vulnerability in the public finances.

“If we if you like support demand on an ongoing basis, it will increase the inflation profile,” Kelly said.

“What I’m not saying is necessarily some of the measures won’t need to be changed, but it needs to be, if you like, neutral in that they will have to be offset somewhere else if we don’t want an inflationary impact.

“Obviously there’s a lot of Government choices where they’re making fiscal policy of those trade offs, so it’s not necessarily some of the current supports might be needed in terms of redistribution, but if we allow temporary measures to work their way into the current spending, they will have an inflationary impact.”

The Bank said actions that support a transition to a more resilient economy where such shocks are less likely to emerge and be less costly in the future remain crucial, and welcomed the use of the windfall element of corporation tax receipts to build up the National Reserve Fund.

 

It said concerted efforts of domestic economic policy are necessary “to sustainably address both immediate challenges such as housing and the green and demographic transitions through appropriate levels and types of investment”.

“This will more readily achieve sustainable growth in the real living standards households and the competitive position of businesses in Ireland over the longer term.”

Growth

The Central Bank said headwinds from higher inflation have reduced the pace of growth, but it expects these to ease gradually through the year. 

Modified Domestic Demand (MDD), a measure which encompasses personal, government and investment spending, grew by 8.2% last year as consumer spending rebounded from the pandemic and physical investment by multinationals in Ireland rose sharply.  

“There was some real one-off spend in terms of big investment happening by multinationals here and that really drove that figure up to a very large growth,” Kelly said.

He said a “key consideration for us is the momentum of investment” and whether it will continue at the same level this year. 

“It is difficult at this point to see the level of investment we saw last year being repeated this year, but looking at the market intelligence, there’s a lot of signs there that investment will continue to grow, albeit not at the level we saw last year.”

The Bank said the outlook for real household disposable income, which underpins the forecast for consumer spending growth, has improved compared to the last quarterly bulletin “given the lower than previously forecast path for inflation and the continuing strength expected in the labour market”.

Real average household disposable income is forecast to grow by 2.1% this year and 2.3% next year, supporting consumption growth of 4.8% and 3.7%, respectively. 

Meanwhile, modified investment growth is expected to ease significantly following a strong outturn last year.

The slowdown is anticipated in both machinery and equipment investment and in building and construction, with the number of new housing units expected to remain below 30,000 both this year and next.

Overall MDD is forecast to grow by 3.1 % this year, 2.9% next year, and 2.5% in 2025.

Employment

The Bank said the labour market is forecast to remain tight, which is set to contribute to a pick-up in wage growth. 

The rate of unemployment forecast to remain around 4.4% this year and next year.

“Slower employment growth and a pick-up in wage growth through the forecast horizon is expected as capacity constraints become more binding, with compensation per employee expected to rise by 6.4% this year and 5.2% in 2024,” the Bank said.

However, it said the adjustments still unfolding in the labour market and in the wider economy as a result of the pandemic and the Ukraine war “point to the need to assess carefully recent and near-term developments and whether they may reflect long-term structural change”.

It said growth in wage rates and profit margins will have to be anchored in underlying productivity growth in the economy for medium-term growth and inflation to be sustainable.

“As price pressures moderate and incomes pick up, consumption should pick up more strongly in the second half of the year supported by stronger purchases of goods,” the Bank said.

Exports

Last year, Irish exports increased by 15% in volume terms, dominated by the activities of multinational companies in ICT services and pharmaceuticals. Around 60% of the growth in the value of Irish goods exports during the year were products shipped out of Ireland.

The Bank said it expects trade in these sectors to provide a continuing boost to economic activity in Ireland over the forecast period. Exports are forecast to grow by 8.2% this year, 6.2% next year, and 7.9% in 2025.

This supports growth in GDP terms averaging over 5% per annum out to 2025.

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